Global Macro Weekly Digest (Issue 104):Brexit update,exit bill could be signed this week,and trade t
The Brexit talks were just as hard as expected. Even with the UK’s Prime Minister, Theresa May, demonstrating a much softer stance during her Florence speech in late September, Brexit negotiations were basically stalled with no actual progresses achieved since then. Mainly due to EU’s hard stance on settling the exit bill first before any talks on transition and other issues, and the tension regarding the Irish border, as well as UK’s internal divergence on the exit bill, the possibility of delayed trade talks and “Brexit with no deal” significantly increased during the past two months. Only until recently, breakthroughs have been achieved: 1) UK finally agrees to fully honor its financial obligations with the EU budget and prepares to pay around EUR 40-50 billion; 2) a broad outline on the Irish border is under discussion between UK and Ireland and an agreement is expected to be achieved as soon as this week.
From the UK’s original hard stances of “no deal is better than a bad deal” to the recent compromises made to satisfy EU’s demands, it has verified our previous view that the UK does not have much leverage in Brexit negotiations and the “no-deal” scenario is the most harmful to UK itself. Thus, it is not surprising to see that, in order to kick off the most important trade talks, the UK has made further concessions to the EU on its financial obligations. Unlike May’s Florence speech which agreed to pay the exit bill depending on reaching the transitional deal, the UK now agreed to fully honor its financial commitments depending on nothing. The gross liability is assumed to be worth up to EUR 100 billion, including contingent liabilities that unwind overtime, and the net payment is expected to be around EUR 40-50 billion (very close to EU’s initial bid of EUR 60 billion), spreading over years. The exit bill is expected to be signed this week, and the actual number may not be disclosed to the public to avoid possible political oppositions. As Germany, France and other EU members appeared to be satisfied with the outline of the exit bill, this could remove one of the biggest obstacles to the Brexit trade talks.
Moreover, another key issue that needs to be solved before trade talks is the Irish border within the Common Travel Area (comprising Ireland and Northern Ireland). The Ireland is seeking concrete guarantees from the UK that there will be no hard border between the Republic of Ireland and the Northern Ireland after UK leaves the EU single market. A month ago, the UK turned down EU’s proposal that the Northern Ireland could remain in the EU customs union after Brexit, and it is now drafting a deal that makes a credible commitment to avoid the hard border. The deal could be finished as soon as this week, but still, it needs to fully satisfy the Republic of Ireland before talks on future EU-UK relations and transition deal could begin.
On UK’s economy, we maintain our previous view that Brexit would increase uncertainties and dampen UK’s growth outlook. Against such backdrop, BoE’s November rate hike was only meant to curb the high inflation caused by the weaker pound; and with the possible breakthroughs in Brexit talks, we see upside risks now outweigh downside risks on the GBP exchange rates. Thus, we do not expect frequent rate hikes of the BoE going forward.
Finally, December could be a busy month for key overseas’ political events to watch. Except for the possible breakthrough of Brexit talks, eyes are also on the US tax reform. After the Senate voted to pass its tax bill two days ago, it now enters the reconciliation process which will determine whether the bill could be signed by Trump before Christmas. Besides, the German coalition talks between Canceler Merkel and Social Democratic Party’s (SPD) leader Martin Shultz are also crucial. After Merkel’s failure of forming the Jamaica coalition with the Green Party and the Free Democratic Party (FDP), the grand coalition with SPD is now the only way to avoid a second election or a minority government. Whether the grand coalition between Merkel (CDU/CSU) and Shultz (SPD) could be achieved is key to Germany or even EU’s future.
