RaboResearch - Economic Research

Brexit Monitor: customs fudge and economic blues

Economic Comment

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The choice of the British population to leave the EU will have significant consequences for trade between the EU and the UK and will therefore affect many companies. Our Brexit Monitor helps you track the latest Brexit developments and anticipate on further progress.

  • Recent developments: all eyes on a customs union
  • Economic developments: 2018 off on the wrong foot

Recent developments: all eyes on a customs union

The solution for a hard Irish border?

The Brexit debate in the UK is currently focused on the issue of a possible customs union between the EU and the UK, because such an union could help prevent a hard border between North Ireland and Ireland. The hard Irish border is a contentious issue the EU would like to see tackled by the end of June, when the next summit will take place.

A customs union between the UK and the EU would eliminate customs tariffs within the union. The UK would furthermore apply the same import duties as the EU on the rest of the world. The union can also imply some regulatory harmonisation (such as alignment of industrial standards)). Given these characteristics, a customs union could facilitate trade post-Brexit, including between Northern Ireland and the Republic of Ireland. However, a customs union would also imply that the UK will have much less autonomy over its trade policy , which is a sensitive issue for the British government.

Disagreement within UK politics could delay Brexit negotiations

The UK government has not yet managed to agree on a solution for preventing a hard border between North Ireland and Ireland. A customs union could help. But the debate about a customs union has polarised both parliament and PM May’s own Conservative party. The prime minister is even facing resistance from within her own team. Nevertheless, support for a customs union seems to be increasing in parliament: the House of Lords has approved many amendments to the Withdrawal Bill that challenge the government’s position in the Brexit negotiations, including an amendment that obliges the government to pursue a customs union with the EU. If the Withdrawal bill passes the Lower House, the government will have to implement these amendments. Meanwhile, the lack of a solution for preventing a hard Irish border risks delaying negotiations with the EU.

Our base case

Given support for a customs union is only slowly emerging, we are maintaining our base case of a transition period followed by a comprehensive Free Trade Agreement for the Brexit outcome. The odds that this agreement will include a customs union are increasing though. A customs union would limit trade restrictions post-Brexit. However, the recent polarisation in the UK politics also increases the chances of a government crisis and thus uncertainty around the Brexit outcome.

Economic developments: 2018 off on the wrong foot

Weak economic growth in 18Q1

According to preliminary estimates of the Office for National Statistics (ONS) economic growth in the first quarter of 2018 decelerated and disappointed. The q-o-q estimate came in at 0,1%, the lowest growth rate since late 2012, down from 0.4% a quarter earlier (figure 1) and below the market consensus of 0.3%. The slowdown can be partially attributed to one off events such as bad weather in March and financial troubles at an important domestic construction company, which contributed to a contraction in the construction sector of 3.3% q-o-q. The weakness was also reflected in other economic and soft indicators such as confidence indices, manufacturing PMI and credit growth. The lower than expected GDP growth in 18Q1 puts downward pressure on our forecast of 1.4% y-o-y growth in 2018.

Figure 1: Economic growth disappoints in 18Q1
Figure 1: Economic growth disappoints in 18Q1Source: ONS, Macrobond, Rabobank
Figure 2: Inflation is decreasing rapidly
Figure 2: Inflation is decreasing rapidlySource: ONS,BIS, Macrobond

Inflation lower, BoE policy rate postponed

Weaker growth also played a role in the rapid and above expectations fall in inflation in recent months (figure 2). Inflation reached 2.5% y-o-y in March 2018, the lowest level in a year. The main driver behind this deceleration are base effects, as the pass-through effect from GBP depreciation after the Brexit vote in 2016 is running out of the books. Nevertheless we expect domestic inflationary pressures stemming from the tight labour market to pick up later this year. For the time being inflationary pressures have ebbed and the Bank of England has postponed a policy rate increase.

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Author(s)
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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