Overnight the UK and EU authorities completed phase one of the Brexit negotiations. This is a very significant step. Agreement was reached on three areas of the negotiations: citizens’ rights, the ‘Brexit’ bill and the Northern Ireland border. This allows the negotiations to move on to phase two and a discussion of the future trading relationship.
Where the EU and UK go from here
The next most pressing area to reach agreement is transition. This is a period of time beyond March 2019 which would phase in the changes to the new relationship. Removing uncertainty in this way would serve as a tremendous relief to businesses on both sides of the continent given supply chains are highly integrated. It may also prevent financial companies in the UK enacting contingency plans, at this stage.
The agreement on the end state relationship is the final prize and the most complex. In this discussion, both sides will have to reveal what compromises they are willing to make. The UK will have to assess whether it is willing to concede on control of its laws, its borders and on an annual payment to the EU as a price worth paying for access to the single market.
Our assessment is that the most likely scenario is one in which compromise will be made on both sides. Given the political results in 2017 on the continent and the fact that, with the recovery, support for the euro is rising, the EU should feel more internally confident. It may feel less inclined to make an example of the UK with a particularly punitive deal and instead wish to avoid near-term supply chain dislocations that could result from a ‘no deal’ scenario.
Implications for investors
As investors we should remember that the EU has been in some sort of apparent crisis for six years and we should remember what we learned during that time about EU political strategy. There was political blustering and brinkmanship. There were numerous column inches dedicated to impending doom. But at the end of the day, economics overruled the politics and solutions were found. The solutions were neither perfect nor definitive; indeed, they often deferred the difficult decisions to further down the road. But ultimately, a way was found to “muddle through”.
In summary, the negotiations may just continue in the background for a long time. In which case, Brexit fatigue may set in among investors, with more emphasis placed on the day-to-day data. If sterling were to hold on to its recent appreciation, then the squeeze on real wages, which depressed consumption in 2017, may ease significantly. If business investment is not entirely paralysed, then alongside less restrictive fiscal policy, an ongoing modest recovery seems feasible.