17 Jan 2017

PM Brexit speech – Sterling avoids another pounding…

Philip Shaw

Chief Economist

PM Theresa May delivered her first major speech on the UK’s Brexit strategy. Our view is that it was very well delivered, achieved a conciliatory and avoided a confrontational tone.

PM Theresa May delivered her first major speech on the UK’s Brexit strategy. Our view is that it was very well delivered, achieved a conciliatory and avoided a confrontational tone. It ran very much along the lines of reports contained in the press over the past few days. Partly because of this, there was little if anything that stood out in terms of policy initiatives.

As trailed recently Mrs May signalled that the UK would not seek to be a member of the EU Single Market as this would necessitate accepting the EU’s ‘four freedoms’, including freedom of movement. The PM also indicated that in a post-Brexit world, the UK would no longer be subject to jurisdiction from the European Court of Justice, nor pay ‘huge sums’ to the EU budget. Instead the UK would seek a bold trade agreement which would be as ‘free as possible’ and would attempt to sign up to elements of the customs union to prevent major frictions in trade.

The PM stressed that the UK was leaving the EU, and that it was not seeking partial or associate membership. However she emphasised that Britain is not leaving Europe and urged on a number of occasions for continued close co-operation in various other fields such as intelligence and defence.

Mrs May outlined twelve objectives that she was aiming for. These included the (obvious) points including the control (although not the end) of immigration from the EU, the control of British laws and a free trade agreement with the EU. But they also encompassed new trade agreements with other countries, maintaining the Common Travel Area with the Republic of Ireland and notably, a smooth, orderly Brexit. The last point has been aired for a while and would be defined by a phased implementation of the changes once the UK actually leaves the EU (presumably in early-2019). As Mrs May put it, the aim is to avoid a ‘cliff edge’. Significantly while the PM ruled out transferring ‘huge sums’ to the EU budget, she did concede that Britain might be prepared to maintain some contributions, for example, to specific projects. She also confirmed that there would be a vote in both the Commons and the Lords on the final deal struck by the negotiations with the European Council.

Sterling rose sharply during the speech. The UK currency was already recovering from its sub-$1.20 lows early yesterday but at the time of writing had gained 1½ cents to $1.2325, albeit against a US dollar which was falling against the euro. Here we take the view that it was as much the PM’s conciliatory tone as well as the content of her speech that supported the pound. Indeed there was relatively little new in terms of the government’s intended approach.

The reality is that the Brexit negotiations are unlikely to be as straightforward as the substance of most of the PM’s speech seemed to imply. Indeed there were a couple warnings to European Council negotiators. Mrs May stated that no deal was better than a bad deal and reiterated the Chancellor’s comments over the weekend that the UK was prepared to change its business model if necessary – code for we will slash our taxes (although no-one is talking about offsetting reductions in expenditure!). But the PM had one opportunity to deliver her a major speech and she took it well.

Our medium-term view on sterling is that a relatively soggy outlook for economic growth (our forecast for 2017 is +1.4%) does not justify the degree of sterling’s undervaluation against other currencies; hence our end-year target is $1.35 and 85p against the euro. However we recognise that the Brexit negotiations will at times be very difficult and highly politicised and that sterling is likely to undergo periods of significant volatility.