One year to Brexit: what’s in store for you and your business?
29 Mar 2018
With only a year to the end of the UK’s membership of the European Union, Investec chief economist Philip Shaw takes stock of Brexit negotiations, the outlook for sterling, examines difficulties that we face and identifies key opportunities.
The Brexit transition agreementLast week, the UK and the EU agreed on some of the terms of the transition period to follow Brexit day at the end of March 2019. The transition is to last 21 months, meaning that the relationship between Britain and the European Union will effectively not change until the end of 2020. While there’s still masses of uncertainty up in the air, the transition agreement is good news.
For businesses, this importantly means more time to plan for the post-Brexit environment. Faced with an uncertain future around the trading relationships between the UK and the EU, businesses might have decided to relocate some of their activities outside of the UK. Now that the ‘cliff edge’ has been taken away, there’s more time to plan, and some breathing space to see what the post-Brexit environment is going to look like.
‘Now that the ‘cliff edge’ has been taken away, there’s more time to plan.’
Main difficulties, opportunities, and caveatsThe main challenge for our clients is going to be maintaining and continuing to develop business within the EU. Firstly, we don’t know what the trading arrangements are going to be between the UK and the EU. When it comes to goods, it’s now widely thought that there won’t be any tariffs, although this is not set in stone. In terms of services, the situation is more uncertain, for example when it comes to financial services. We don’t know what type of access the UK is going to have to EU jurisdictions, and vice-versa, and that can make life very difficult.
In terms of opportunities, it is in principle possible that the UK could strike more advantageous trade deals with third-party countries. For example, we can see the United States being ‘very keen’ to develop trade relationships with the rest of the world – but in practice striking a trade deal is much more difficult than making a friendly statement, especially given current international tensions over tariffs. But there is a possibility. Another opportunity is that, so far as the relationship between the EU and the UK is uncertain, it’s not impossible that you begin to see some EU businesses move into the UK, because they are uncertain of the access they will have to Britain.
So there are some opportunities there, however with the caveat that trying to strike trade agreements with large economies is often difficult and it takes time. An average EU trade deal takes five to seven years to complete. The UK should be able to do it quicker, as it won’t have to pass each deal with 28 countries, but it will also not have the EU’s negotiating advantage of a huge market with 500 million people.
Theresa May set out proposals for the future trading relationship between the UK and the EU early in March. It is hoped that a broad agreement on this will be settled by October.
Sterling after Brexit: effect on the poundThe pound has already fallen sharply after the referendum. At current levels, which is about $1.416 against the US dollar, it's fundamentally still cheap. With the progress on Brexit talks, the pound has risen, recouping about 40% of its overall losses since the referendum.
We still view sterling as being undervalued – it’s still pricing significant downsides from Brexit. If you’re looking at a post-Brexit environment where the UK has only slightly less advantageous terms in certain areas, does that really justify sterling being around $1.40 rather than, say, $1.60? In our view, it doesn’t.
Brexit is the main driver of the UK currency at the moment, and may well continue to be for a while, but as talks progress, we would expect a possible upward influence on sterling.
What we should also remember is that other important factors are also going to influence the pound over the medium term. One important subject is politics, and over the course of the next two to three years, investors will be looking more at what a possible Jeremy Corbyn government would mean for the economy. So even if we do get positive news on the Brexit negotiations, they may be offset by what’s going on in the domestic political arena.
In terms of business opportunities, if the pound falls back, this does present an opportunity to export. However, looking at what happened over the past year, it doesn’t look as if the value of the pound has lent material support to export growth. What seems to have helped exports a lot more is the strengthening of the world economy, in particular the rest of the EU. The size of that market coupled with the strength of recovery there does seem to have lifted the UK manufacturing sector. So, sure a weak pound would in principle help, but in practice, the strength of the global economy is the important factor.
‘If you’re looking at a post-Brexit where the UK has slightly less advantageous terms in certain areas, does that really justify sterling being around $1.40 rather than, say, $1.60? In our view, it doesn’t.’
Philip Shaw, chief economist
Brexit and savings/ interest ratesIf the worst comes to the worst and the UK doesn’t strike a deal with the EU on Brexit, in general, it would be bad news for the economy. In terms of interest rates, the implications are not very clear.
While the economy would be weaker, the supply potential of the British economy would arguably also be reduced. As the Bank of England's mandate is to set interest rates to meet its inflation target, it’s not clear whether demand or supply would be the predominant factor. So, it might well be that initially the Bank of England would cut rates again, to bolster confidence, but my guess is that they wouldn’t stay lower for very long.
Implications for Britons retiring abroad, buying property and doing business cross-borderDuring the transition period, very little will change for British people living abroad. After that, we don’t know. UK nationals don't automatically have the right to reside in other European countries – currently, that right is granted by the fact that Britain is an EU member. That’s still something to be discussed during Brexit negotiations.
In terms of property prices, a lot will depend on the exchange rate. If you’re looking at a rising pound, that arguably makes it easier, as property prices overseas will cost less in sterling terms and those Britons moving abroad who have a sterling income might find that the pound goes further in their country of residence. Of course, the reverse is also the case, and that's what has been happening in the past year and a half.
London property’s attractiveness to foreign investorsFor people coming into the UK, if the pound falls back, that may make property more attractive for foreign businesses, but a more important factor is what you’re allowed to do as a business in the UK with the rest of the EU and that’s the much bigger question.
David Davis, UK’s Brexit minister, hosted chief Brexit negotiator Michel Barnier at Downing Street in February. Barnier then warned the UK of ‘unavoidable’ trade barriers when quitting the customs union.
Doing business with EU countries: tariffs, customs and technologyOne of the main areas that businesses are looking out for is what happens to tariffs. It’s not an unreasonable assumption that tariff-free trade will continue between the UK and the EU after the transition period finishes. But of course, another benefit of being a member of the EU is that customs clearance is relatively simple. What happens here is again a big question mark, given Westminster’s insistence that the UK will not be in a customs union with EU countries post-Brexit.
Whether it’s more advantageous for UK businesses to be part of a customs union or not is a matter of opinion. If Britain is, then it’s not able to strike trade deals with third-party countries – it’s a matter of swings and roundabouts. The view of Theresa May’s government, and there’s obviously a lot of politics in this, is that not being in a customs union with the EU post-Brexit is the best option.
Simple customs clearance saves businesses a lot of money and time, and there may be some temptation for UK companies to relocate at least some of their activity outside the EU. It will depend on the specific needs of that firm and how costly relocation is.
‘In principle, the use of technology in customs clearance may be feasible in the future, both in the context of Ireland and generally.’Is there a possibility of friction-free trade borders in future, even if the UK leaves the customs union? In principle, yes. My guess would be that the use of technology in helping customs clearing procedures is going to be an increasing option as time goes on. At the moment, it’s thought that the technology is not sufficiently developed to enable this, and certainly not by the end of the transition agreement. But in the longer term, why not?
The government has two suggestions on how to keep an ‘open’ border between Northern Ireland and the Republic outside of the customs union. The EU judges that neither of these is feasible in the timeframe concerned and the various parties are attempting to find a working solution. I’m not an expert on this, but in principle, the use of technology in customs clearance may be feasible in the future both specifically in the context of Ireland and generally.
On 19 March, Davis and Barnier announced that the UK will be able to agree, but not implement, trade deals with non-EU countries during the agreed transition period.
Doing business with non-EU countries, including South Africa: developing trade agreementsAnother relevant, but often forgotten area of interest for UK businesses is the future costs of doing business with other countries where advantageous trading arrangements are already in place. As an EU member, the UK has trade agreements with around 60 different countries outside the EU. Technically, once you leave the EU, perhaps even during the transition period, those trade relationships will fall away, and they may have to be renegotiated.
South Africa is one relevant example of that. In this case, UK trade negotiators will have to reach some sort of deal with the South African government on what the trade relationships between the two countries are going to be like. And there are about 60 of those countries, depending on how you count them.
It seems likely that the international trade departments will be very keen to start working on new trade agreements. However, I’m not sure what they can achieve in a limited period, especially with the larger economies and given the rather fractious world background at the moment, especially the trade tensions between the US and China.
So, it’s not impossible that we get a new trade agreement, in principle, with another small-ish country, which would be good news. However, bearing in mind that the EU absorbs over 45% of UK’s exports of goods, it remains highly significant, irrespective of how other economies are growing. In the near-term at least, you have to be realistic about how much of an impact on the big picture you can make by signing new trade deals.
The state of UK business confidenceAhead of the referendum last year, I spent six months travelling around the country and abroad speaking to clients, prospective clients and industry groups. At the time, there was a considerable feeling that, were the referendum to swing in favour of leave, then the uncertainty that that would bring about would mean that companies would feel more reticent to spend money on big capital projects and even employing more people.
Now that we’ve steered away from worst-case scenario over the past 18 months or so, if you look at business investment, it’s about 2% up to a year ago. So, it is growing. Would this investment be greater had there been a remain vote? The truthful answer is that we don’t know. But the general point is, the more uncertainty the government can close off, the better prospect they’ve got of investment strengthening. The trading relationship between the UK and the EU has to be clarified. And from the perspective of labour availability, that will include the UK specifying what migration policy is going to be.
‘As an EU member, the UK has trade agreements with around 60 countries outside the EU. Technically, once you leave the EU, those trade relationships will fall away.’
Philip Shaw, chief economist
Implications for financial servicesAs mentioned before, the impact on finance companies will depend on the deal reached for financial services, which we don’t know yet.
Some institutions have already moved some of their business units away. The one major point that London has in its favour, however, is the excellence of its financial infrastructure. If you want to do a deal, you can do the entire deal in London. You’ve got the corporate finance and funding experts, the banks, the investors, the lawyers, accountants, the whole lot. London is a fully accomplished financial centre with critical mass. If you want to move out, you give up all those benefits with risk.
It’s a strong argument that London will continue to be the financial centre of the world for quite some time. But it doesn’t preclude banks shifting some businesses out of London because of uncertainty or other reasons. At the end of the day, banks move business units all the time – it’s part of the way the sector functions.
When we should know moreThe main date to keep in mind is the EU summit on 18-19 October – that’s when it is hoped that the agreement on the future relationship of the UK and the EU will be settled. It could be that the timetable slips by a couple of months, still allowing ratification by March next year. If not, we could see broad agreements in principle, and the full legal details sorted out during the implementation period.
As for full legislation, most legal experts insist that there’s no way that it can be completed by the time of Brexit. It’s too complicated. When you start trawling through some of the details of various issues – again customs clearance is a good example here, especially for firms with complex cross-border supply chains – you soon realise the scale of the complexity. So, we may get into the transition period and beyond without the whole deal being finalised, and it’s not impossible that the transition period is extended. That is not the government’s or the EU’s intention, but you wouldn’t rule it out.
This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of information provided.
About the author
Chief Economist, UK
Philip graduated with an Economics degree from Bath University and a master’s in Econometrics from the University of Manchester. He is a regular commentator on the economy and financial markets in the press and on TV. Philip joined Investec in London in 1997 and heads up the Economics team there.