E.U. to Accept May's Brexit-Bill Offer in Order to Keep London's Finances Flowing say Goldman Sachs

“The EU-27 has a financial and an economic incentive to accept that proposal. The EU-27 will face a financial shortfall without it" - Andrew Benito, Goldman Sachs.

Prime Minister Theresa May is to deliver a major speech in Florence on Friday, September 22 in which she is to update on the UK's evolving position regarding Brexit. 

She is expected to set out the amount the UK is willing to pay in order to settle their accounts with Europe on exit from the European Union.

The contents of the speech, and initial responses from Europe could be key for financial markets, and Sterling in particular.

May is muting the payment of a €20 billion settlement bill upon Britain’s exit, according to the FT, as part of an attempt to move the Brexit negotiations on from the subject of the so called “Brexit Bill” and onto the future trading relationship.

Recall that for Pound Sterling to avoid any further substantive declines markets want to see the EU and UK making progress in Brexit talks in order to avoid a disorderly Brexit. 

Indeed a disorderly Brexit is seen as the worst possible outcome for the Pound.

Thus far, the onus has been on the UK to bend to the EU's wishes, as they are the senior partner in negotiations thus far, but there must come a time for the EU to show flexibility as we know the UK will eventually be pushed back onto their own red-lines.

Indeed, a new note issued by Goldman Sachs confirms the EU needs a good deal to be struck with the UK and as a result analysts at the bank forsee a transitional period being agreed upon.

May will use her Florence speech to try and push the EU into some form of compromise, and the EU will be hoping the UK offers enough concessions to allow them to make that compromise.

EU Will Ultimately Accept the Offer

The initial reaction to any offer, or suggestion put forward by May is likely to met with scepticism from key European officials.

Watch the Twitter accounts of Guy Verhofstadt for an early indication of the tone we can expect from Brussels.

Ultimately though, EU negotiators are incentivised to accept Prime Minister Theresa May’s reported offer of cash-for-transition Brexit deal, according to economists at Goldman Sachs.

Brussels faces a budgetary black hole after Britain’s exit and any forthcoming exit settlement will be key in balancing the budget.

But, Europe's needs extend beyond just the settlement.

Goldman Sachs argue Europe will still need unfettered access to the City of London in order to ensure the financial pulse of Europe keeps beating.

Goldman Sachs believe the EU will cede ground.

"Expect PM May to depart from the legalistic approach in her Florence speech, to
suggest that EU payments will depend on reaching a transitional deal," says Andrew Benito, an economist at Goldman Sachs.

The payments Benito expects to be agreed upon at this stage are ongoing Budget contributions that serve as an “associate membership” fee.

The payment covering legacy costs will follow later.

"The EU-27 has a financial and an economic incentive to accept that proposal. The EU-27 will face a financial shortfall without it,” says Benito

“While the EU-27 may have been reassured to find that its economy has been insulated from any Brexit effect, the main risk to that would be if the flow of financial services from the UK to wider Europe were interrupted on the failure to reach a transitional deal,” says Benito, emphasising the merits of the offer.

Budget contributions and the “Brexit Bill” are an incendiary topic in Westminster and were a key point of contention in Foreign Secretary Boris Johnson’s recent public interjection of opinion over the direction of May’s Brexit negotiations.

May’s offer will plug the budgetary hole left behind when the UK’s regular contributions stop flowing to Brussels, which was expected to happen before the next eight-year spending plan is agreed in Brussels at the end of 2020. She is expected to formally announce the offer at a Florence speech on Friday, September 22.

“We expect a significant contrast between PM May’s speech on Friday and her earlier confidence that no transitional deal – and, therefore, very little compromise – would be needed before the UK could take back control over its “borders, laws and money.”

EU Wants a Deal

A survey of EU governments conducted by Bloomberg show a majority are still concerned at the prospect of the U.K.’s departure.

It is reported that France sees an imperative to hinder any risk to bilateral trade worth a total of some $57 billion last year, with specific concerns over agriculture and cooperation on Airbus SE aircraft.

Athens is menawhile said to be worried about the consequences of a so-called hard-Brexit that the Bank of Greece estimates could cost as much as 0.8 percent of Greek gross domestic product.

The Bloomberg survey reveals, "a majority of governments were willing to consider a transitional arrangement with the U.K. to avoid the prospect of a disruptive exit without an agreement in place, but several stipulated that it must be clearly defined, limited and come at a cost."

United We Prosper, Divided We Fall?

This week's reports from The Telegraph suggest UK Foreign Secretary Boris Johnson is now lined up behind May’s position and that he won’t be sacked, or quit, in response to May’s Brexit intervention.

This puts to bed fears of a leadership challenge and the domestic political uncertainty - something the Pound is loathe to contemplate.

But the risk of unrest could remain in the background as it is not clear whether May’s proposal will be enough to put European claims to a so called “Brexit Bill”, or a challenge from Johnson, to bed once or for all.

“We expect the ‘divorce bill’ due from the UK to cover legacy commitments made while the UK was an EU member to emerge as a separate discussion and a separate sum of money,” says Goldman Sachs’ Benito.

Earlier press reports put the EU’s total “Brexit Bill” demand within a wide range, with the lower end being €50 billion and the upper end being €100 billion.

Foreign minister Johnson made large payments to Brussels and post-Brexit budget contributions a red line in his own vision for Brexit, set out in The Telegraph last weekend.

“Our view has been that the UK will concede to the EU-27 on making contributions to the EU budget, on accepting free movement of labour and accepting jurisdiction of European courts on a temporary basis to secure a transitional deal,” says Benito.

Beyond Politics; Sterling Has Turned A Corner

The Pound held onto recent gains Wednesday, supported by a surprise-surge in UK retail sales for the month of August, as traders continue to price in a rate hike from the Bank of England in November.

“Today’s retail sales figures indicate that consumers are showing an impressive resilience in the face of the ongoing real pay squeeze,” says Ruth Gregory, an economist with Capital Economics. “Not only did retail sales volumes rise by a hefty 1.0% on the month in August – exceeding consensus expectations of a 0.2% rise – but growth in the previous month was revised up from 0.3% to 0.6% too.”

Markets have expected the BoE to hike since last Thursday when Gertjan Vlieghe, one of the Monetary Policy Committee's staunchest advocates of lower-for-longer interest rates, told an audience that the time for a rate hike could be near. This was after the Monetary Policy Committee warned of action to come if inflation continues to rise over the coming months.

But Vlieghe’s assessment of the economy, and merits of a rate hike, were based on the assumption that consumer spending had begun to pick back up after a first-half slowdown. Wednesday’s retail data could have all but obliterated this picture.

“Admittedly, we shouldn’t get too carried away by these figures. After all, the retail sales figures are very volatile on a month-by-month basis,” Capital Economics’ Gregory notes. ”And high-street spending growth has been on a clear downward trend, with the annual rate of sales volumes at 2.2% in the three months to August – considerably lower than the 5-6% rates seen towards the end of 2016.”

The Pound-to-Euro exchange rate was quoted 0.04% higher at 1.1272 in late morning trading while the Pound-to-Dollar rate was up 0.15% at 1.3535.