Hard Brexit or no Brexit no. 11

BPCC Brexit Brief No. 11: 30 June 2017

Much has changed since the last Brexit Brief was published on 5 May. The general election has come and gone. Theresa May’s majority in the House of Commons didn’t increase to the 100+ seats predicted; it disappeared altogether. The Tories, however, continue in power as a minority government, propped up by an agreement with the Democratic Unionist Party of Northern Ireland, whose ten MPs give Mrs May a working majority.

Rather than clarifying the situation as the UK began negotiating with the EU in earnest, the election outcome weakened Mrs May’s hand. Internal arguments within the cabinet between proponents of a longer transitional period (Chancellor of the Exchequer Phillip Hammond) and a more brusque departure (Brexit minister David Davis) suggest the UK’s negotiating position remains unclear.

Mr Hammond emphasises an early deal on citizens’ rights and a transitional arrangement that “allows the complex supply chains and business relationships that criss-cross our continent to continue to deliver value.”  Mr Davis, on the other hand told foreign company executives that the UK will be “fully outside the customs union and single market by March 2019”.

Mr Hammond’s stress on delivering a Brexit that prioritises the economy is seen as being at odds with Mrs May’s insistence on a Brexit that’s primarily focused on migration and legal sovereignty.

Should Mr Hammond’s vision prevail, the UK’s relationship with the EU may end up akin to that of Norway or Switzerland (in terms of market access and limits in migration restriction). As a result hard-line Brexiteers and Remainers are both saying ‘Hard Brexit or No Brexit’, though with entirely different conclusions in mind.

The Labour Party’s approach to hard Brexit is interesting. Leader Jeremy Corbyn is at heart anti-European, his left-wing sensibilities offended by the notion of open markets and competition policy that comes down hard on state aid. Having done remarkably well at the general election by attracting some of UKIP’s working-class voters in the north, Mr Corbyn seems to be pushing for a hard, take-control-of-the-borders Brexit. He sacked three of his front-bench shadow ministers for defying the party whip. The three (plus a fourth who resigned) were among 49 Labour MPs who voted for an amendment to the Queen's Speech brought by backbencher Chuka Umunna calling for the UK to remain part of the single market after it leaves the EU. On matters Brexit, Mr Corbyn has again shown that can be counted on by the government for support in Parliament.

The status of EU nationals in the UK is currently in the spotlight after Theresa May set out the government’s proposals. These were met with dismay by many Poles living in the UK, in particular the fact that those who’ve already obtained their residency permits after filling in an onerous 85-page questionnaire will have to go through the whole procedure again to obtain an EU citizen’s ID card after Brexit.

In the meanwhile, a Survation poll showed that a majority of British voters would now opt for Remain should there be a second referendum (56-44).

Macroeconomic indicators

The UK is currently a member of the EU, the single European market and customs union and will continue to be so, to the end of Q1 2019. Then will come be a dangerous moment for the UK economy – especially should a comprehensive trade deal (which includes services) not be in place in time, or a transitional period agreed.

Meanwhile, GDP growth for Q1 was revised downwards by 0.1 percentage point to 0.2% quarter-on-quarter, mainly as a result of downward revisions within the services sector. Growth in Q4 2016 had been 0.7% q/q.

However, unemployment fell to 4.6% in the three months to April, the lowest rate for 42 years. It is likely to fall further, as migrant workers from the EU drift home (or move to other countries), and fewer new ones arrive – the result of a weaker pound and a less welcoming environment. But a shock to many was the announcement by the Royal College of Nursing that the number of nurses coming to the UK from EU countries in the past 12 months fell by 92%. Labour shortages, especially in sectors that are heavily reliant on migrant labour such as agriculture, horticulture, hospitality and logistics, are likely to stoke wage inflation.

Rising wages are but part of the inflation story – the falling pound is already feeding into rising prices for imported goods. CPI inflation for May 2017 is 2.7%; a sharp increase on the 0.8% CPI for June 2016. Consumer prices are expected to continue rising. The question is how much more inflation can the UK economy take before the Bank of England raises the base rate from its historically-low 0.25%. Governor Mark Carney’s statement that a rise is ‘likely to become necessary’ led to a short-term strengthening of the pound, which soon fell back. An increase will have a negative effect on consumers paying off home loans at such low interest rates, and would slow down economic growth.

Polish-UK trade

Despite the strong zloty, Polish exports to the UK continue to rise. In the first quarter of this year, the value of Polish goods sold to the UK was over £2.6 billion, while the value of British goods sold to Poland was £1.15 billion. Ever since 2012, Britain’s trade deficit in goods with Poland has exceeded the value of British goods sold to Poland. The weak pound seems to have given UK exports to Poland a slight boost (each month since the referendum has seen exports above previous levels), but over the past months Polish exports are growing much faster in value.

Currency markets

The outcome of the general election was a shock to the markets. The pound fell by 12 grosze against the zloty (from 4.85 to 4.73) in the aftermath, before settling down around the 4.80 level, being brought back due to hawkish comments from Mr Carney and other members of the Bank’s monetary policy committee.

But let’s have a look in three charts how the pound has fared against the zloty, the euro and the dollar in the 12 months after the referendum. [Data and charts courtesy of Ebury]

All three charts show a similar pattern, with markets reacting sharply to subsequent political news (Theresa May’s Conservative Party conference speech in early October, which seemed to signal a hard Brexit, Donald Trump’s election on 8 November, the calling of an early election in the UK, and Emmanuel Macron’s victory over Marine Le Pen in April, and the weak showing of Theresa May’s government in the 8 June general election. Though the events moved the markets in the same direction, the amplitude of the changes differed.
Against the dollar, the pound has been steadily gaining ground since its pre-inauguration low of $1.20, unmoved by political perturbations in the UK. The last month saw the pound pulling back to $1.30; ahead of the referendum it stood at $1.49.

Against the euro, the pound has been move volatile, though showing a gentle upward tendency since January, oscillating between €1.10 to €1.14 after its dramatic post-referendum fall from €1.31.

Keywords brexit