The Merchant of Westminster

On Thursday, April 13, 2017Category: Ludovic Subran
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shakespeare. image courtesy of MikeBird pixabay.com under CC0.png

​As the UK strides – or rather hobbles – out of the EU (see infographic at the end of this post), it is worth taking a keen look at what Britishness might stand for. Ask anyone in the world, and at the top of their ranking, somewhere between Scary Spice and hangover-proof food that I, as a Frenchman, am barred from tasting, they might place William Shakespeare.
Granted, the British national treasure never set foot in Europe. But his worldview and writings were infused with continentalism.


The bard scattered memorable protagonists in Bohemia, Venice, Verona and France.  Much like the British, much like today, his Europeans were passionate and – more often than not - deranged.
If you Brexit them, do they not get Brexited? Oh but they do.
More than four centuries ago, the playwright espoused freedom of movement and labor. In Sir Thomas More a London mob is censured for attacking foreign workers.  A French doctor cares for the local community in the Merry Wives of Windsor.
Shakespeare incorporated words from French, Greek and Latin, including one that could be useful to guide the UK’s current dealings with Europe: compromise.
Which is where, much like as in All’s Well That Ends Well, exit negotiations should lead. The not-so-happy but not-too-disastrous mix of infighting, seduction, betrayal, and outmaneuvering needs to end up with some sort of reasonable co-habitation.
Oh, Europe. Oh, Britain.
Thus, looking at the current state of Brexit affairs through a tragic-comedy lens makes a whole lot of sense. Consider this: Act 1 ended with fewer calamities than expected. The United Kingdom proved to be resilient. In a new study, Euler Hermes expects this to persist until mid-2017 when consumer spending would take a hit from higher inflation and slowdown in wages. Uncertainty will weigh on investment, but not stifle it. The UK’s GDP, which climbed by a modest +1.8% in 2016, could stoop to +1.4% in 2017, and reach a mere +1.0% in 2018.
Lights. Curtain.
Time for Act 2. Enter the merchant of Westminster, Theresa May. As negotiations kick-off - or rather begin at a crawling speed – the British government pins its hopes on concluding more than an amiable divorce within two years. The UK vies for a comprehensive trade deal.
It seeks to guarantee unencumbered access for specific sectors in return for contributions to the EU budget. In addition, the aim is to obtain a phased implementation of the next trade agreement. But the timeframe is not realistic to agree both a trade and an exit deal.
The solution? Yes. Compromise. One could expect a transitional deal covering EU-UK relations to be reached in 2019. It should bridge the gap between the end of Brexit negotiations and a final Free Trade Agreement (FTA). In return, the UK would have to abide by the EU rules. Call it Measure for Measure if you will. The EH study assigns an 80% probability to this economic scenario.
But wait. The plot thickens. Because once a transition deal is reached, there is always a probability – the authors put it at 55% - that only a limited FTA will be negotiated.
And if the poisoned cup is gulped in full, there’s the low yet menacing risk (20%) of no transitional deal and no free trade agreements.
Then it would be a story of “Alas, poor Britain. I knew her! A country of infinite J-curve, of most excellent finance.”
I did mention I do not expect a Hamlet-magnitude catastrophe.
In the base economic scenario British household spending will see a sharp decline over the course of 2017-21: down from +3.0% in 2016 to +0.8% in 2021.
As for UK companies, over the negotiation period, companies in the UK, businesses – and notably SMEs - will face two challenges. First, lower profitability due to rising input cost inflation driven by the pound depreciation and higher commodity prices. Given the high share of imported intermediate goods, high input costs will at least partially need to feed into higher selling prices in order to ensure profitability Secondly, there is the issue of lower domestic demand, with uncertainty holding back investment and consumer spending. There’s also higher non-payment risk. We expect business insolvencies in the UK to increase going forward, by +5% and +6% in 2017 and 2018 respectively.
As for UK exporters, after the EU exit (2019), the impact will be very different under the three scenarios outlined above. But the key point is the very limited competitiveness gains from the sterling depreciation.
The Tempest might come, yet it is not inevitable
What about markets? These seem to have already priced in a “Sensible divorce”. Yet fidgety investors can punish the pound or treasury GILTS, especially if a deal is not outlined quickly. British equities could end up in a tight spot as more than 70% of the FTSE 100 constituents’ revenues are generated outside the UK.
Ahead of the EU exit agreement in 2019, companies doing business in the UK or exporting there will be negatively affected through the currency depreciation (-5% on average), the slowing domestic demand and rising insolvencies (+5% in 2017 and +6% in 2018). As for monetary policy, the BoE is likely to be tolerant of inflation above 2% for the next few years as the economic outlook deteriorates. Interest rates are thus set to remain unchanged until the final deal is effective. When it comes to fiscal policy, the government remains committed to a stimulus.
As for neighboring countries, looking at trade and investment relationships, the EU members which could be most impacted are the Netherlands (-1.8pp of GDP growth cumulative 2017-21 in the baseline scenario), Ireland (-1.2pp) and Belgium (-1.0pp). Overall, we expect a moderate impact on the Eurozone GDP (-0.4pp). In the adverse scenario (WTO option in 2019) the impact would exceed -0.5pp as exports from EU countries to the UK will be subject to 3% tariffs and that the sterling would fall as much as 20%.
What would Shakespeare, a true son of the renaissance, say about where Britannia might be heading? Hard to say. But perhaps a fifth final act of a Brexit play would offer no catharsis, but rather a lingering pain.
A limited FTA between the EU and the UK will fall well short of the degree of integration that has been achieved within the European single market. After Brexit key pillars of Britain’s economic success – such as the financial services industry – will be less strong. Brexit does not have to be an economic disaster in the long term, but in the long run the UK will clearly be worse off, if access to an EU market with more than 450 million people is at least partially restricted.
If EU-UK negotiations do not produce an agreement, the British government has might opt to lower the corporate tax rate, relax regulations. There is talk of turning the country into a kind of “Singapore of the West”.
How fitting and tragicomic that we should all be asked at the end to forget Shakespeare’s beloved Verona, Sicily and Troy.

Ludovic Subran
Chief Economist
Euler Hermes
 

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On Friday, December 08, 2017