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Brexit update: no news is good news … and some hopeful signs

Economic Comment

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  • Prime Minister (PM) May survived the Annual Conference of the Conservative Party unscathed
  • That strengthens her position domestically but the threat of a leadership challenge by her party persists
  • The big announcement at the Tory Conference was a new immigration policy after Brexit, one that would curb net migration, in particular low skilled
  • Labour also held their annual conference and reframed their Brexit position to not only favour a customs union with the EU, but also a referendum as a solution of last resort
  • The UK is reportedly working on an alternative backstop for preventing a hard Irish border, one that would de facto keep Northern Ireland in the EU and the whole of the UK in the EU Customs Union, though probably temporarily
  • The proposal is controversial but there are reasons to believe it might turn politically palatable
  • Negotiations between the EU and the UK are expected to intensify ahead of the EU top on 18-19 October
  • Lack of progress on the Irish conundrum by then could derail talks and thereby increase the odds of a ‘hard Brexit’
  • Meanwhile we maintain our basecase that the EU and the UK will reach a last minute deal that stipulated a transition period and a Free Trade Agreement after that. Nevertheless, the risks of a hard Brexit remain uncomfortably high

She May stay

The Conservative Party held its annual conference between 30 September and 3 October, an important milestone for the position of PM May. Given the high degree of polarisation in her party and the rage amongst Tory Brexiteers about her shift towards a softer Brexit in July, the conference was regarded as a possible platform for hardliners to mobilise and challenge PM May’s leadership. That could have had her removed from her Prime Minister function. Not only did this not happen, but important figures in the pro-Brexit camp such as Boris Johnson and Rees- Mogg actually expressed support for Theresa May. All arrows were pointed at PM May’s plans for the future relationship with the EU, also known as ‘Chequers’, a proposal that not only enjoys little support domestically but has also been rebutted by the EU. The fact that the congress has passed without much ado strengthens PM May’s position. Some regard it as a sign that Brexiteers cannot garner enough support for a leadership challenge. While they need only 80 Conservative MP’s to start a motion of confidence, they need 166 Conservative MP’s to proceed and party rules allow for such an attempt only once in 12 months. PM May seems out of the woods for now, but the threat of a leadership challenge will hang above her head until March 2019, particularly is she further softens her Brexit stance.

New immigration plans

The big announcement at the conference was the cabinet’s post-Brexit immigration policy according to which decisions will not be based on “where somebody comes from, but on the contribution they will make to the UK economy, and so it will be a skills-based system.”

The purpose of the system will be to reduce net immigration, particularly inflows of low skilled workers. Even before policy changes the Brexit referendum has already had an impact on both migration flows and stock. Net migration to the UK has fallen significantly since 16Q2 driven by a lower number of EU migrants coming in, EU8[1] citizens in particular (figure 1). In 2018, the number of foreigners employed in the UK fell for the first time since the financial crisis, driven by a fall in EU employees (figure 2). Migration from other parts of the world is offsetting the reduction in EU migration to some extent.

Figure 1: Lower net migration to the UK after the Brexit referendum
Figure 1: Lower net migration to the UK after the Brexit referendumSource: ONS
Figure 2: Number of foreigners employed in the UK is falling
Figure 2: Number of foreigners employed in the UK is fallingSource: ONS

Footnote

[1] EU8: Poland, Lithuania, Czech Republic, Hungary, Slovakia, Slovenia, Estonia and Latvia.

Labour increases the pressure

Labour also held its annual congress and that led to a slight repositioning of the party’s official stance on Brexit:The party has expressed support for a new Brexit referendum, but only if a deal with the UK is rejected by the UK Parliament and parliament cannot trigger general elections. While that does keep a ‘Bremain’ scenario alive, we regard the actual chances of it materialising as  very low. More importantly, the party’s leader Jeremy Corbyn has reiterated his party’s support for a customs union with the EU: “Britain should stay within the basic terms of the single market and a customs union for a limited transition period”, and that is positive news for the approval of an eventual divorce deal through the UK parliament now that the solution for the Irish border seems to be heading into this direction (see below). Labour also used the conference to make announcements over the party’s economic agenda and  spooked the business sector some more with rather radical rhetoric such as intentions to make large British companies hand over up to 10% of their shares to a trust for employees.

‘No hard Irish border’ in sight?

The Conservatives’ Annual Conference hadn’t even finished when rumours of a solution to the Irish border being in sight surfaced. The UK is reportedly working on an alternative to the EU’s backstop for preventing a hard Irish border between Northern Ireland and the Republic of Ireland. The alternative plans keep Northers Ireland in the EU Single Market regulatory area, while keeping the whole of the UK in the EU Customs Union, rather than the EU’s proposal for only Northern Ireland to remain part of the latter. This construction is not a surprise as it has been ventilated by some experts in recent months.

There are a couple of issues with it though. First, PM May relies on the Irish DUP for a majority in the UK parliament and the party vehemently opposes additional regulatory divergence between Northern Ireland and the UK. However, one can argue that this is not a dramatic change as Northern Ireland’s laws already diverge from the rest of the UK in certain areas (e.g. abortion prohibition law, phytosanitary checks on animal transportation from mainland UK). Moreover, given labour’s expressed support for a customs union as well as possible support from pro-EU conservative MP’s, such a proposal might find enough support in the UK parliament. Second, the proposal breaks the UK’s red line of pursuing an own trade policy, though it maintains the other three red lines (on immigration, EU’s Court of Justice and contributions to the EU budget). However, being a backstop, the proposal is likely to be presented as temporary, until a better solution is available. It is also positive that on 5 October Liam Fox, a Brexiteer and UK’s Trade Secretary, expressed his support for a pragmatic Brexit that pulls the UK out of the EU in March 2019, rather than pursuing ideological options.

All in all, this proposal might fly domestically. The EU has reportedly been reluctant in showing support for it. However, only as recent as 26 July chief EU negotiation Bernier said ” I have always said that the EU is open to a customs union” which “would come with our Common Commercial Policy for goods.” (the official name for EU’s trade policy).

Negotiations full speed ahead

Negotiations between the EU and the UK were resumed after the Conservatives Conference and are expected to maintain a fast pace ahead of the EU summit on 18-19 October. A lack of progress by then could derail talks and that would increase the odds of a ‘hard Brexit’ markedly. The EU has made an additional EU summit in the mid of November contingent on such progress. Recent news on an alternative UK backstop for the Irish border is encouraging. The UK is expected to present this proposal to the EU before 10 October. Around the same time Barnier is expected to present the draft political declaration on the future relationship with the UK to EU commissioners and the ambassadors of the EU27. All in all, time is running very short for the EU and the UK to find common ground on the main unresolved issues in the Brexit negotiations. Risks of a hard Brexit therefore remain uncomfortably high. But given the fact that the EU and the UK remain constructively engaged in negotiations we maintain our expectation that the two will reach a last minute deal on a comprehensive Free Trade Agreement starting in 2021, after a transition period (figure 1). A temporary Customs Union could be part of the solution. Nevertheless, we also stress that the odds of a ‘hard Brexit’ remain uncomfortably high.

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

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