Pound Sterling Could Gain as May puts Free Trade as Top Objective, No Recession say Capital Economics
Maintaining free trade with the rest of the EU is fast becoming the top priority for Theresa May and her government, with potentially positive consequences for Sterling which has seen considerable pressure against the Euro, US Dollar and other G10 currencies.
What is clear now, though, is how serious the new prime minister is about maintaining a link with Europe, especially in terms of free trade, and this could well be a positive driver for Sterling in the medium to long-term.
Protecting free trade with the rest of Europe seems to have taken pride of place at the top of Theresa May and her negotiation team’s agenda, according to recent reports, making it now less likely Brexit would mean the UK is cut off from the single market.
Clearly from a currency perspective this would be a boon for the Pound, as it would restore - all other things being the same - much confidence in the ability of companies based in the UK to trade freely with the rest of Europe.
This would no doubt remove investment from the metaphorical head-lock it has been in since the run-up to Brexit, when companies began shelving investment plans until the parameters and costs of a new trading deal with Europe became more clear.
It would also keep flows of incoming investment from outside of the EU open, as the likes of Nissan continued to see the UK as a viable production base for feeding sales into the rest of the European region.
May’s Plan for a New Deal
In an attempt to chart a middle way between EU membership and complete isolation, Theresa May's post-Brexit administration appears to be attempting to build on the ruins of David Cameron’s ill-fated (and now jettisoned) ‘deal’ to impose an in-work benefits ‘emergency brake’ for immigrants of up to four years.
May’s idea appears to go further by requesting a total cap on immigration for a set period of time - between 7 and 10 years - in return for keeping its free trade rights as part of the European single market.
“Plans to allow the United Kingdom an exemption from EU rules on freedom of movement for up to seven years while retaining access to the single market are being considered in European capitals as part of a potential deal on Brexit,” saus Toby Helm in the Observer/Guardian.
“Senior British and EU sources have confirmed that despite strong initial resistance from French President Hollande in talks with Prime Minister Theresa May last week, the idea of an emergency brake of free movement of people that would go far further than the one David Cameron negotiated before the Brexit referendum is being examined,” Helm goes on to say.
One of the main reasons for Theresa May’s EU Diplomatic tour could be to sow the seeds of some of these negotiation tropes, before the actual negotiation’s proper begin in the autumn.
May has already met with Merkel, Hollande and Italy’s Mateo Renzi, in what could be a tour to soften up heads of state before negotiations begin.
No Recession
Institutional forecasters tore up their projections in the wake of the EU referendum with many forecasting recession to take hold.
The decline in output in May sets a poor base for growth in Q3 and will be compounded by the uncertainty created by the vote to leave the EU. Indeed, surveys received this week point to a further deterioration in growth in coming months.
The output expectations balance of the July CBI Industrial Trends Survey fell to a level that is consistent with an annual contraction in manufacturing output. What’s more, the July CBI Distributive Trades Survey and GfK consumer confidence both suggest that a slowdown in retail sales growth is imminent.
But these surveys capture the immediate reaction to the vote to leave the EU argue Capital Economics who say the pessimistic surveys could be reflecting a short-term, and fleeting, shock:
"They were mainly conducted in the first half of July, which was a period of extreme political uncertainty. This political uncertainty has since eased, mainly due to the appointment of Theresa May as Prime Minister on 13th July. Accordingly, we think the economy will stagnate in the second half of the year, rather than experience a full-blown recession."
Another reason why Capital Economics think the effect of Brexit on the economy won’t be too severe is the response from policymakers. Markets’ implied probability of a rate cut at next week’s MPC meeting has risen to 100%!
"We agree with market expectations that Bank Rate will be cut by 25bps next week and we also think the MPC will announce an increase in the Asset Purchase Facility (i.e. QE) of £75bn," say Capital Economics.
The Perspective of the EU
The EU for its part, must perfect a balancing act between trying to keep the UK in the single market because it is beneficial to Eurozone exporters, but also not being seen to give in to the UK's demands too easily.
The main danger for the EU is that if the UK gets what it wants – the May deal of access to the single market with controls of freedom of movement - this will set a bad example to other vacillating members, and could lead to copycat defections.
“EU diplomats and advisers believe the EU should try to keep the UK in the single market if possible, while not giving it such a good deal that other member states would be tempted to follow it out of the club.”
Currently it seems EU officials would not necessary object to the May-like plan, based on certain conditions.
One such condition would, for example, be that the ‘emergency brake’ on immigration would have to be ‘time-limited’ to the 7-10 years and not longer.
This is so that it would conform to EU law, which does have a clause allowing members to impose “safeguarding measures” in the event of “serious societal, economic or environmental difficulties of a sectorial or regional nature liable to persist.”
This clause could be invoked as a cover for the UK’s plan to limit freedom of movement.
Another condition would be that EU citizens already living in the UK would have to have their current rights “guaranteed permanently”.
Indeed, May told her Polish counterpart on Thursday the 28th July that the 800K Poles living in Britain will be able to stay following a Brexit.
Continued membership of the trading ‘club’ would also mean the UK would have to continue paying a contribution to the EU budget – scotching in a trice the idea that 350m a week could be saved to buy new hospitals and schools, as some Brexit campaigners had claimed, however, it is also the case that the size of the contribution would be less that it is now.
EU announces France’s Bernier as EU Chief Brexit Negotiator
It is clear feelings are mixed amongst Europeans about the UK’s decision to leave.
Whilst some respect the will of the people, many still feel a sense of bitterness and betrayal, and this could be hard to overcome in future negotiations.
It could be argued that Jean Claude Junckers, EU Commission President, for example, might be one of those bearing a grievance - at least if his choice of Chief Brexit negotiator for the EU is anything to go by.
He chose an experienced French politician, Michel Bernier, who was described as the “scourge of the City” and “the most dangerous man in Europe” when he was the EU’s financial regulation czar.
He has been described as ‘Gaullist’ and ‘anti-Anglo-Saxon’.
Bernier was the architect of the EU’s post-crisis financial regulatory framework, and managed to lead a mutiny against the UK, when it was overruled on new bank capital controls the EU wanted to impose in 2013.
According to sources quoted in the Financial Times, some saw his selection as provocation:
“Some City financiers were even more scathing about the appointment. One chairman said: “My initial reaction was ‘Oh, God.’ It’s clearly provocative.”
“I can’t see how it could be worse,” said another senior banking industry figure, who has worked in Brussels. “It’s incredibly provocative. This is Juncker’s revenge on Britain.””
The FT points out, however, that the commission will only be one of three parties in Brexit negotiations, the other two filled by the UK and Member States representatives, however the commission will have a key part to play because of its “technical expertise”.
The UK’s Telegraph paper, also appears to see the choice of Bernier to head up negotiations, as reflecting a desire by the EU to play “hardball”, after it ran an article claiming the new negotiator ‘blamed England’ for losing his job as French Foreign Minister – though their explanation seems a bit too convoluted.
Bernier lost his job as after a referendum in his native France went against him on the EU constitution.
It was claimed the only reason the referendum had been allowed was because the French though the British were going to hold a similar referendum after Ton Blair suggested as much.
In the end the UK did not hold a referendum, but Bernier lost his job anyway.
Nevertheless, the FT does also say that as his tenure progressed Bernier’s relationship with the city improved:
“Towards the end of his five-year term in 2014, Mr Bernier’s relations with London were on a more even keel — looking back, he recalled “good spirited” tussles with George Osborne, then chancellor.”
It goes on to quote the man himself:
“My line has been the middle line,” he added in the interview. “There is no sense to build European financial regulation without the City, no sense, no credibility. My first wish was to build a compromise. It was never easy, it was sometimes impossible. For the rest we reached agreement and it was never by chance.””
Time will tell whether or not Bernier’s appointment will become a thorn in Britain’s side, as he will not begin his appointment until October 1, and there are many negotiations still to come.
However, what is clear is that in preliminary remarks he has already adopted a ‘hard line’ saying that during negotiations we shouldn’t become hostage to “the British question,” and that the principle of Freedom of Movement must be accepted by the UK if it wanted to remain in the single market, “without exception or nuance.”
What is clear now, though, is how serious the new prime minister is about maintaining a link with Europe, especially in terms of free trade, and this could well be a positive driver for Sterling in the medium to long-term.
