RaboResearch - Economic Research

Brexit Update: Flextension, the sequel

Economic Comment

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  • Article 50 was extended for a second time during a special EU summit on 10 April
  • The new cut-off date is 31 October, the date by which the UK must have approved the Withdrawal Agreement (WA) and have translated it to domestic law
  • An earlier departure is possible as soon as the UK ratifies a withdrawal deal with the EU
  • The UK has committed to holding European Parliament (EP) elections
  • However, PM May is pushing for approving the WA before this day so that the UK does not have to follow through on this commitment
  • The 6-month extension pushes a hard Brexit further away. The risk is that the urgency to find a Brexit consensus in the British Parliament will be reduced
  • Failure to break the deadlock could lead to a political crisis and an early general elections
  • Events that could possibly trigger this are another parliamentary rejection of the WA, major losses for the Conservatives in the local elections on 2 May or in the EP elections on 23 May
  • An early general election could pave the way to a referendum; a further extension beyond 31 October would be needed to accommodate it
  • An orderly Brexit remains our base case and current talks with Labour bode well in that sense
  • However, given the gridlock on Brexit in British politics the odds of a Hard Brexit remain high
  • The half year extension pushes a hard Brexit further away, but is not without economic costs

The ‘flextension’

New cut-off date

The EU27 leaders unanimously approved a second extension of article 50 during the special Brexit EU Summit on 10 April. However, once again they did not approve the requested 30 June as the new departure date. Instead they drafted a proposal that sets the new cut-off date to 31 October (Figure 1). The 20-21 June EU Summit will be used to take stock of the progress in the UK towards an orderly Brexit, but it does not represent a hard deadline. The 31 October deadline seems to be a compromise between the one-year long extension envisaged by various EU27 leaders and the objection of French president Macron. The date might also be related to the fact that the new EU Commission is appointed on 1 November. By setting the departure date to 31 October the EU leaders are implicitly excluding UK nationals from these key positions. The new Brexit date pushes a hard Brexit further down the line for now. Further delays cannot be ruled out since the EU has not taken a hard line on a third extension. And that reduces the odds of a hard Brexit somewhat.   

Early departure

The UK can leave the EU before 31 October if it ratifies a withdrawal deal with the EU. PM May is pushing for ratification before 22 May so that the UK does not have to hold EP elections. This might prove overly optimistic. It is questionable whether the rest of the British Parliament has the same sense of urgency about avoiding EP elections as the PM, particularly since many MP’s might see the extra time as an opportunity to push for their preferred Brexit outcome through Parliament after all. Given Easter recess between 11 -23 April the PM May has only one month for her attempt to spare the UK population from casting a vote on an institution many prefer to leave.

Figure 1: Important milestones in the Brexit process
Figure 1: Important milestones in the Brexit processSource: Rabobank 

Worst of both worlds?

The (roughly) 6-month extension is basically not short enough to maintain the time pressure on the British MP’s to reach a consensus on a desired future relationship quickly, but also not long enough to allow the UK to change its mind on leaving the EU. The biggest risk is that it could make the British Parliament complacent about the time they will have to reach a resolution on Brexit. 31 October seems far away, but recess periods reduce the time to just four months, which on top of it are frontloaded: three of the four months of parliamentary activity take place before the summer recess starting on 20 July. And in this same period British politics could be distracted by local elections on 2 May and EP elections on 23 May. Also, the EU Summit of 17-18 October brings the actual decision on Brexit forward by two weeks. All in all, the half year extension can be deceiving since the actual time available for achieving an orderly Brexit is in fact closer to three months. That is particularly worrisome given PM May’s inclination to procrastinate, procrastinate, and then turn up the pressure on MP’s.  

On the other hand, the half year extension is not long enough to allow the UK to change its position on leaving the EU. Well, theoretically it is possible if the government were to revoke article 50, but this still looks like a remote outcome. A referendum is estimated to require a minimum of 21-24 weeks for the organisation and is thus only possible if the UK were to immediately pursue this option, which is highly unlikely. Hence a Bremain only becomes viable after a third article 50 extension, which remains a possible outcome.

What the future may bring

The way to an orderly Brexit

We maintain our view that an orderly Brexit remains the most likely outcome and the extension provides more room for reaching this outcome (Figure 2). We have long argued that the path of least resistance to an orderly Brexit would be to work across the Commons and to leverage on Labour’s support for a permanent Customs Union with the EU. The talks between the government and the Labour party, which started a week before the EU summit, bode well in that sense. Particularly as PM May has recently hinted that there might be some common ground around pursuing a Customs Union with the EU as the future relationship. In our view, a customs union is not very different from the current deal and hence not a softer Brexit. Namely, to prevent the Irish backstop from kicking in the EU and the UK must agree on a deal that keeps the Irish border frictionless. This is likely to lead to an FTA that also includes customs arrangements comparable to those in the Irish backstop, which is why a comprehensive FTA plus a customs union remains our base case for the future relationship.

Downside risks

Risks to this base case are tilted to the downside. The main risk is a persistence of the current gridlock in the British Parliament, particularly as the extension might cause the sense of urgency to temporarily wane. Against this backdrop several events (or a combination thereof) could spark a political crisis and lead to an early election, namely: a large defeat in another meaningful vote, very poor performance for the Conservatives in the local elections or in the EP elections. This is most likely to happen as a result of a motion of confidence by Labour, though a spate of key cabinet resignations could also push the PM towards this option. Some have also mentioned a Conservative leadership change as a threat, but this risk seems much lower as the Tories don’t have the tools to remove Theresa May until December 2019. On the back of these risks we also assess the odds of a hard Brexit to remain uncomfortably high.

There is no costless Brexit

More than two years of Brexit negotiations have already taken their toll on the UK economy. The main channels have been the post-referendum GBP depreciation in 2016 and the persistently high levels of uncertainty ever since. The later has pushed investments in negative territory in 2018, at a time of high conjuncture, or at least that is what the tight labor market and the high degree of capacity utilization seem to indicate. While the extension does push a hard Brexit further down the line, it also perpetuates a very high degree of uncertainty and that is likely to come at an economic cost.

For those who had been implementing measures to mitigate the risks of a hard Brexit, like stockpiling, the half year extension is a nightmare. The period is namely too short to allow companies to unwind such measures and at the same too long to contain the costs of maintaining such measures until the new departure date. This is likely to put quite a strain on the liquidity of some companies, as highlighted by the director of Make UK, the manufacturing industry’s trade body.

Figure 2: Where does Brexit go to from here?
Figure 2: Where does Brexit go to from here?Source: Rabobank
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Author(s)
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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