Brexit: To be continued…

Macro FX
Christopher Dembik

Summary:  Following an inconclusive EU Summit on Brexit, the U.K. prime minister will decide today whether to persist with talks. We think neither the United Kingdom's October 15 deadline nor the EC's October 31 deadline really matter, and we expect that talks will continue until the last minute in order to bridge differences. In the best case scenario, an agreement must be found at some point in early November in order to be subsequently ratified by the end of the year. In today's macro update, we discuss the main points of disagreement between the EU and the UK and what lay ahead in the coming weeks for investors in a Q&A format.

Q. What was the outcome of yesterday’s EU Summit on Brexit ?

A. The EU Summit was inconclusive, as expected. Backed by all EU counterparts, French president Macron was in full bad cop mode, ready to defend French fishermen. The EU agreed to extend trade talks beyond the U.K. prime minister’s October 15 deadline for a few weeks, and called for concessions on fisheries, state aid and regulations (especially socially and environmentally). We think neither the October 15 deadline nor the EU’s October 30 deadline constitute a hard stop and we expect negotiations to continue in coming weeks. At the end of the day, we still expect a thin agreement to be reached, ideally in early November in order to be subsequently ratified by the end of the year. Some hot topics might be left temporarily on the side in order to reach a deal and will certainly be discussed beyond 2020.

Q. Why negotiations are taking such a long time ?

A. The whole matter is obviously very complicated, but it is also obvious the United Kingdom’s strategy to negotiate with the EU is ill-adapted. First, the U.K. government was mistaken to believe a medium sized country of 67 million people could impose its views to a trading bloc of 400 million people. From an economic perspective, it is bright clear that the United Kingdom needs the EU more than the EU needs the United Kingdom. The trade relationship is very unbalanced: the United Kingdom buys over 600 products exclusively from the EU while the EU only buys one product exclusively from the United Kingdom (a species of wood). In case of hard Brexit, it is thus easy to know which one would be the most economically hit. The Europeans have fully understood that the United Kingdom has particularly low bargaining power in the current negotiations. Secondly, for most EU leaders, the big political and economic story is not Brexit, but the fact that Europe is locking down again to cope with the pandemic and will need further economic support to recover. Said differently, Brexit is at the bottom of the EU political agenda.

Q. What are the next steps ?

A. This is the updated Brexit timeline:

This weekend: the EU chief negotiator Barnier is expected to come to London.

November 5: Bank of England monetary policy meeting.

At some point in November: Special EU Summit to sign-off deal ?

December 10-11: Last EU Council of the year.

December 31: End of the transition period.

January 1, 2021: The EU implemented full border control, more gradual in the UK.

July 1, 2021: The UK implements full border control.

Q. Should we be prepared for the political fragmentation of the United Kingdom after Brexit ?

A. Until now, this scenario has not been priced in by investors. We think the risk is elevated that Brexit will open the door to a second referendum on Scottish independence. Since the Brexit referendum, the Scottish government has always highlighted that Scotland should be given a choice between Brexit and independence. History teaches us the hard way it is always tricky to know the outcome of a referendum but what is interesting is that the latest polls confirm the Scottish independence sentiment has gained traction as we are approaching Brexit. According to a poll by IPSOS MORI covering the period October 2 to October 9, 58% of respondents are in favor of independence, which constitutes an historical high point, while 42% of respondents want to remain part of the United Kingdom. From an economic viewpoint, an independent Scotland is not a panacea. In the far north of the European continent, an independent Scotland would be highly sensitive to oil revenue, would probably not have a currency of its own, and would need to deal with an hypertrophied financial sector with banking assets around twelve times greater than GDP. In addition, it would be confronted with a challenging twin deficit of about 10% of GDP. We don’t really see how the independence dream could end up well in these circumstances.


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