The UK is hurrying towards the exit but may not be sure where it is going
On Friday, January 31st, the UK will leave the EU ‘in word if not in deed’. There may be political fanfare in Britain including the launch of a new commemorative coin and a light show in Downing Street. However, the vast majority of businesses and people, both in the UK and across Europe, will see no practical changes at least until the agreed transition period finishes at the end of this year. Until then, the UK will be treated as though it were an EU member state and EU law will continue to apply in the UK. The longer term perspectives for the UK economy remain unclear and most likely less promising given the enormous economic and political challenges the UK will face. Moreover, Brexit is likely to remain a cloud above the European economies.
Not a pivot point but the start of a challenging process
January 31st will not be an immediate pivot point for the UK or its partner economies in the EU. At the margin, the removal of the immediate threat that the UK might crash out of the EU could prompt a small and temporary ‘Brexit Bounce’ in sentiment and spending in the UK and, to a lesser extent, in its key trading partners in the EU.
If the very short-term economic impacts seem limited, the longer-term consequences could be substantial. January 31st 2020 marks a momentous date in what has already been a long and twisting path to Brexit. The UK will pass the point of no return and can no longer seek to stop the Article 50 exit process. It will no longer have a voice in EU decision-making. After a tortuous divorce process stretching over three years, the UK will seek to negotiate within at most eleven months, what Boris Johnson has indicated should be a broad free trade agreement with the EU covering goods and services, and cooperation in other areas. This appears, at best, hugely ambitious (See KBC Economic Opinion of 31 October 2019).
A major problem in earlier talks was sharp divisions on Brexit
within the British parliament and the broader UK population. For
several reasons, the very decisive outcome of the recent British
general election may also pose problems for the upcoming
The Conservative party, previously a minority government, now has a
very large 80 seat majority significantly because of its election
promise to ‘get Brexit done’. UK voters seem fed up with the drawn-out
exit process, making the UK likely to prioritise a speedy clean break
with the EU over the more patient but protracted efforts to reach a
A second influence is that the recent election has changed the
complexion of the UK parliament with Brexiteers now firmly in charge.
The UK team negotiating with the EU will be more inclined to believe
that, outside the EU, the UK will have enhanced scope for independent
policy-making that will deliver greater opportunities for British
business, offsetting the costs of more limited access to the EU single
A final important influence is the absence of any dramatic adverse
Brexit impact thus far on UK households. The latest data show
unemployment at 3.8%, average earnings at 3.3% and inflation running
at 1.3%. A supportive policy mix, a more competitive exchange rate and
the fact that post-Brexit impacts have yet to be felt mean that many
UK consumers now see earlier dire warnings as unfounded. Forward
looking indicators such as chronic weakness in business investment or
softness in the housing market have attracted little attention.
For these reasons, there are significant risks that the UK
approaches upcoming negotiations with speed prioritised at the expense
of substance, with more emphasis on the benefits rather than the costs
of divergence from the EU, and with a continuing difficulty
understanding how the EU’s strategic imperatives and economic scale
would influence the shape of those negotiations.
In the same vein, the UK Government’s decision to incorporate
measures in British law that prevent it seeking any extension to the
transition period may not achieve the intended goal of strengthening
its bargaining position. As a result, early indications of the UK
approach may hint at difficult discussions to come and recurrent
threats that the UK might crash out of the EU at the end of this
Complicating matters further is the UK’s ambition to simultaneously
conclude trade deals with a range of other countries, with some
suggestion that a mooted deal with the US would enhance the UK’s
bargaining position vis-à-vis the EU. However, early indications that
Washington would look unfavourably on a proposed digital tax in the UK
and Huawei’s involvement in the roll-out of 5G in the UK point towards
the scale of problems the UK may face to quickly realise its stated
ambition to become ‘a champion of free trade’ .
Economic reality may clash with political rhetoric
For the EU’s part, Commission president Ursula Von der Leyen spelt
out the principles and priorities informing its negotiating stance
with the UK very clearly in an early January speech in London, noting
‘...our partnership cannot and will not be the same as before…The more
divergence there is, the more distant the partnership has to be. We
will work for solutions that uphold the integrity of the EU, its
single market and its Customs Union. There can be no compromise on
Clear differences in the approaches signalled by the UK and EU, and
the current political mood in Britain make it unlikely that the UK and
EU will extend the transition period beyond the end of the year. This
also means that any trade agreement will probably be ‘narrow and
shallow’ and primarily focussed on trade in goods, with limited
progress likely on trade in services and possible difficulties in
concluding definitive arrangements in areas such as security and
So is a deal technically impossible? On the evidence of previous EU
trade deals, an eleven-month timeframe looks entirely inadequate to
reach agreement with the UK. However, given the extent of existing
linkages and commonalities, it might be possible to make sufficient
progress on the broad outline of a meaningful if limited agreement to
allow some form of fudge delivering a provisional deal and creating a
‘technical implementation period’ beyond the end of 2020.
Reaching such an outcome would depend critically on the extent to
which the EU is satisfied that the UK will respect a ‘level playing
field’, entailing commitments in a range of areas including state aid,
social and employment standards, the environment and relevant tax
matters. Recent rhetoric from the UK emphasising its intention to
avoid alignment is not encouraging, but some creative emphasis on
commonalities might overcome this obstacle if the insurmountable task
of delivering a line by line trade deal within a reasonable timeframe
is to be avoided.
Significant obstacles to delivering even an outline of a very basic
trade deal between the UK and EU suggest that Brexit concerns are
likely to remain a large and threatening cloud hanging over the
British and European economies in the year ahead. Even if these
obstacles can be overcome, the sort of free trade deal now envisaged
by the British Government is likely to have serious negative impacts
on UK economic activity over time.
The UK Treasury has estimated that ending frictionless trade in goods and significant curbs on trade in services between the UK and EU could leave UK GDP about 7% lower than in a no Brexit scenario -an amount equivalent to the cumulative growth in the UK economy in the four year period from 2016 to 2019. The fact that this might not happen all at once does not markedly diminish the risks in this regard, even if it sustains claims that a bright alternative future for Britain is now coming into reach. Between the nominal Brexit date of January 31st and the likely effective departure date at year end when the transition period concludes, significant gaps between political rhetoric and economic reality in the UK could be painfully exposed.