Outlook on UK-EU Brexit negotiations and possible economic risks

Abstract

The UK parliament on 29 January endorsed by 317 to 301 votes a government-backed amendment proposing to renegotiate the Brexit deal with the European Union, specifically demanding major changes to the so-called backstop on future border management between the UK region of Northern Ireland and the Republic of Ireland. EU negotiators, as well as leaders from the remaining 27 EU member states, have repeatedly stated that they reject such a move. While still failing to approve viable alternative routes, the UK parliament also confirmed in a nonbinding vote with a majority of 318 to 310 that it is opposed to leaving the EU without a deal. The easiest route is for the UK to secure an orderly Brexit on 29 March would require major EU concessions to the backstop, such as agreeing to a time limit or providing a unilateral exit clause for the UK. But, the EU continues to rule out a renegotiation, suggesting May could struggle to win some concessions to win over support from hardline Brexiteers. Should the EC refuse to budge on the backstop agreement, parliament could demand a legally binding vote to remove a “no deal” option from the table, increasing the likelihood of the UK edging closer to a softer Brexit instead. This could entail the establishment of a permanent UK-EU customs union, which could attract sufficient number of votes from the opposition as well as an array of pro-EU MPs from the governing Conservative Party. However, May has so far refrained from offering such an option as it would significantly increase the risk of splitting her party. Without either EU concessions or a cross-party alliance supporting a softer Brexit, the risk of exiting without a deal on 29 March increases. At this point in time (4 February), IHS Markit's assessment that the risk of a “no-deal” Brexit is more elevated, and sits uncomfortably around a 25–30% probability range.

Even before we examine the impact of a “no deal” outcome on the UK economy, the continued Brexit uncertainty represents a significant hit on business sentiment, with many firms bemoaning the continued lack of clarity and expressing deep shock that the no-deal option remains on the table. Business groups continue to highlight the lack of contingency planning for a disorderly Brexit. Specifically, London Chamber of Commerce and Industry chief executive Colin Stanbridge reports, “75 per cent of London businesses that we surveyed still haven't made any provisions in preparation for Brexit. Furthermore, the survey also reveals that 86% of businesses in London employing under 10 people have made no preparations at all due to lack of resources and time.” More encouragingly, some have welcomed the fact that parliament has indicated that it is against leaving the EU without a deal, although it is not legally binding. Indeed, Huw Evans, the director-general of the Association of British Insurers, noted that it was “encouraging to see Parliament saying it won't support a no-deal outcome”. Overall, parliament's indecisive vote on the Brexit path signifies that there has been no progress towards how the UK will leave the EU, with many UK firms angry that the point of departure is getting ever close. They highlight that the continued uncertainty is damaging business sentiment and economic activity. Indeed, the latest survey data suggest that the UK economy was close to stagnation in the final month of 2018 and point to limited growth in the first half of 2019. At this stage, we continue to advocate a cautious near-term growth outlook, with the UK economy set to expand by 1.1% (the January consensus is 1.4%) in 2019 and 1.3% (consensus at 1.6%) in 2020 from an estimated 1.3% gain in 2018.