Brexit, the final countdown
All views as at 16 September 2020.
- The most likely Brexit outcome appears to be no-deal or a bare-bones free trade agreement.
- Although some agreement seems to have been reached on tariff-free and quota-free trade in goods, a deal on services is not on the agenda. Fishing and state aid remain major hurdles.
- Forecasting the short-run economic impact of no-deal is challenging, but we would expect the UK economic outlook to be revised sharply lower. We expect to downgrade our growth forecasts by between 3% and 5%.
The range of potential scenarios appears to have narrowed
The UK withdrew from the European Union (EU) on 31 January 2020 and entered a transition period, during which the two sides were supposed to agree their future relationship. The transition period ends on 31 December 2020.
With the relationship between the two sides increasingly strained, it now appears that the range of potential scenarios for this future relationship have narrowed. Of the four main scenarios we had as possible, a bare-bones deal or no deal are now the two that appear most likely. We have never anticipated a smooth path to a deal; both sides need to be able to claim a victory when any final compromise is agreed, but it now appears that a comprehensive free trade agreement is out of reach. This leaves a bare-bones free trade agreement at best, although some small enhancements may be possible.
Two scenarios remain
- Bare-bones goods only FTA: From 1 January 2021 the two sides enter a bare-bones goods-only free trade agreement with no quotas or tariffs on goods, but restrictions on services.
- No-deal WTO Brexit: The UK leaves the transition period on World Trade Organization (WTO) terms with no trade deal and tariffs imposed by both sides on 1 January 2021.
We outline the framework of these two scenarios in Table 1 below:
Table 1: The lively shape of the UK exit
|No-deal 'WTO' Brexit||'Bare-bones' Free Trade Agreement|
|Tariff barriers||Yes||Mostly no|
|Free to negotiate trade deals||Yes||Yes|
|Apply EU regulations||No||Some likely|
|Frictionless northern Ireland border||No||No|
|Vote on EU rules and regulations||No||No|
Source: Insight, Bank of America Global Research, September 2020.
The final days of negotiation
As the negotiations enter their final stage, the UK appears to have accepted the principle that the fewer obligations it signs up for, like Level Playing Field provisions, the less market access it gets in return. The UK has reportedly dropped their demand for a Swiss-style series of individual treaties, instead largely accepting the EU's proposed structure of one central trade deal, with separate treaties for a few select areas such as fisheries and security. In return for the UK's compromise on the structure of the deal as outlined above, the EU have reportedly softened their demand that the European Court of Justice should play a central role in enforcing any deal. Timelines are now short, and we outline the key remaining dates in Table 2.
Table 2: Key dates
|24 - 25 September||Extraordinary European Council Summit in Brussels|
|28 September - 2 October||Ninth formal round of trade talks|
|15 - 16 October||European Council Summit|
|31 October||Barnier’s suggested deadline for agreed Treaty text to allow for member state ratification|
|10 - 11 December||European Council Summit|
|31 December||End of the transition period|
Assessing current progress
Although tariff-free and quota-free trade in goods appears to be agreeable, there are likely to be greater non-tariff barriers such as less advantageous Rules of Origin requirements. With the UK exiting the Customs Union, customs checks are inevitable and are likely to lead to delays, which will impact cross border supply chains.
Given the UK’s wish for regulatory autonomy, the EU is offering the UK access to EU markets on very basic non-EU “third country” terms. That means no mutual recognition of professional qualifications, and no protection from the various barriers to selling services that exist at member state level within the EU. In financial services, the EU has said that the UK will be judged via its “equivalence” framework. But earlier commitments to complete equivalence assessments have been dropped as the negotiation have faltered, and the EU has stated it won’t be able to assess equivalence in some sectors because its own rules are in flux.
The UK is trying to protect the status quo in as many sectors as possible but does not appear to be placing a high priority on securing services access and has tended to accept the EU’s premise that regulatory autonomy means constrained access. The EU side does not appear particularly concerned about any potential loss of access to purchasing services from the UK. There are likely to be additional agreements covering the judiciary, veterinary standards and data adequacy. With the latter, the EU needs to decide if the UK’s data protection regime is regarded as “adequate”. This would allow the storing of personal data of EU nationals on servers that are based in the UK.
The remaining disagreements
The last important areas of contention appear to be:
- Fishing: The UK is demanding a huge reduction in EU access to UK waters, and would like annual renegotiations based on the scientific method of zonal attachment. The EU claim that such an outcome would lead to a partial destruction of its fishing industry and is calling for a moderation in the UK's position.
- State Aid: The EU appears to have dropped demands for the UK to both sign up to all the EU's current rules and to improve them in line with the EU going forward ("dynamic alignment"). Instead, Mr Barnier has recently called for a "shared philosophy" between the respective state aid systems.
- Northern Ireland: The issue of a hard border, either between The Republic of Ireland and Northern Ireland, or Northern Ireland and the rest of the UK has become a key focus, with a breakdown of trust on both sides. The UK House of Commons has passed the Internal Market Bill to mitigate against the government’s perceptions that the EU will attempt to disrupt the UK’s internal market. This is seen as a breach of the Withdrawal Agreement, leading to a joint statement from the leaders of the European Parliament’s political groups and members of the UK Coordination Group that the European Parliament would, under no circumstances, ratify any agreements between the EU and the UK.
What could happen to the UK in a no-deal scenario?
Forecasting the short-run economic impact of no deal is tricky given few precedents and uncertain parameters of the scenario, but we would expect our economic forecasts for 2021 and possibly beyond to be revised sharply lower. If sterling falls to reflect the UK’s lower growth path, and if rising frictional costs are passed onto consumers, then it would create upward pressure on inflation, but this would likely be counterbalanced by a wider output gap and possible measures to reduce VAT.
At the end of the transition period, EU trade agreements will not apply to the UK. To ensure continuity of trading arrangement for UK businesses, the UK is trying to reproduce the effects of existing EU agreements. If the effects of an existing EU agreement are not reproduced, then trade with other WTO members will take place on WTO terms.
- A trade agreement has been reached with Japan, this largely replicates the EU-Japan trade deal that came into force in 2019, but with a greater focus on UK-specific issues than the broader EU deal. This benefits Japanese car manufacturers and UK food exporters.
- A mutual recognition agreement1 has been signed and negotiations on a FTA are underway with the US (19% of exports), although no conclusion is expected before the end of 2020. Mutual recognition agreements have also been signed with Australia and New Zealand, but Canada and Singapore are still in negotiations.
- Countries representing 27% of the UK’s exports have either agreed to a status quo situation or had no agreement with the EU to begin with.
- Trade agreements for the remainder of UK exports (48%) will be worse due to loss of single market or customs union (or both).
Table 3: Summary of future trading relationships
|New UK trade relationship||% of UK exports||Main examples|
|Potentially better||21%||US, Japan|
|Same||27%||Switzerland, China, Australia|
|Still negotiating||4%||Canada, Singapore|
|Worse||48%||EU, Norway, Turkey|
Source: Insight, EU, UK Government, September 2020.
1A mutual recognition agreement (MRA) means countries recognise and accept the processes and procedures necessary for a product to be confirmed as meeting the specified legal requirements.
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