BREXIT UPDATE: CRUCIAL WEEK AHEAD

Off to a bad start: Ahead of the next round of official UK-EU negotiations on the future relationship beginning tomorrow in London, two pieces of news today tilt the risks to the downside for any potential progress this week and for hopes for a deal by year-end. First, according to various UK news reports, UK Prime Minister Boris Johnson will announce today that the deadline for securing a UK-EU deal is 15 October - ahead of the end-October official deadline that Chief EU negotiator Michel Barnier referred to in his Dublin speech last week. Second, according to the FT, the forthcoming UK regulations (Internal Market Bill) that will set out the workings of the UK single market could ‘undermine the agreement on Northern Ireland that Boris Johnson signed last October to avoid a return to a hard border in the region’. Together, the news skew the risks for the outcome at the end of the year away from a full or partial deal and more towards a disorderly hard exit than was the case so far. It adds to the near-term risks to the UK economy.

Misguided: Whether this is a Trump-style negotiating strategy to up the ante in the hope that the EU will blink as the clock ticks down or a conscious approach by the UK to undermine the ongoing negotiations on the future relationship and settle for the hardest possible exit from the EU single market instead of a compromise is unclear. It seems odd, to say the least, that the UK could be about to undermine its commitments to Ireland with upcoming legislation after the UK had recently taken steps in recent months to prepare Northern Ireland’s border for exit day. It suggests the UK is trying to increase the pressure to get a deal more to its liking rather than going for a hard exit. Either way, the strategy does not raise the chance of a good outcome. With the costs of a hard exit falling disproportionally on the UK, the strategy could harm the UK more than the much bigger EU. For the UK and the EU to find compromises on the sticking points – level playing field, governance and fisheries – both sides must work to build trust. The UK’s actions are doing the opposite. Worryingly, the UK seems to be ready to run the potentially dangerous risk of a hard border returning between Northern Ireland and the Republic of Ireland.

Back to the Irish question: The precise contents of the UK’s Internal Market Bill and the extent to which they would undermine the Withdrawal Agreement is not yet known. The document is due to be published on Wednesday. But, according to FT reports today, sections of the bill may contradict parts of the legally binding agreements between the UK and the EU on state aid and, critically, the Northern Ireland Protocol. As a minimum condition for any deal, the UK must adhere to the legally binding commitments it signed up to in the Withdrawal Agreement. This includes taking the necessary steps to ensure that there will be no new frictions on Northern Ireland’s southern border with the Republic of Ireland.

Watch UK politics closely: Ever since the UK voted to leave the EU in June 2016, commenters have frequently warned about a potential collapse in talks. Despite a few close calls, this has never happened yet. During the Brexit negotiations, the UK regularly talked tough but, ultimately, made the necessary concessions to strike a deal – mostly notably when Johnson agreed to keep Northern Ireland de facto in the single market in November 2019. Things might be different now, however. Johnson is under pressure from his party over the badly managed pandemic. The influential Brexit hardliners in his party favour the hardest exit possible. Johnson may thus be inclined to do what suits his own political interests best rather than what is good for the UK overall.

Downside risks: The developments skew the risks away from a full or partial deal (35% chance) towards a hard exit. While our base case remains a semi-managed hard exit (60% probability) which involves some modest stopgap measures to manage the transition from EU to WTO rules for trade, the rising tensions could limit the breadth of any such measures. More than before, we have to watch the tail risk (5%) of a disorderly hard exit at the end of the year. A hard exit with few or no intermediate steps to manage the adjustment in key areas like goods trade and financial services could tip the UK back into recession in early 2021 and temporarily slow the EU recovery. The persistent threat of a major second wave of COVID-19 and the return of national lockdowns – although unlikely – add to the cocktail of risks to the UK economy.

Kallum Pickering

Senior Economist
Phone +44 203 465 2672
Mobile +44 791 710 6575

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