Brexit

September 2020 | Victoria Bogner, CFP®, CFA, AIF®

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Here in the United States, we don’t hear about Brexit much these days.  That’s ancient history, right?  The UK voted to leave the EU four years ago, after all.  But in reality, it’s still in flux and one of the biggest issues across the pond.  The transition period ends on December 31, 2020, and the repercussions of trade negotiations that take effect January 1st, 2021 could be felt in your own pocketbook.

The soap opera that is Brexit has had several twists and turns since the original “leave” vote in 2016.  It’s hard to predict what will happen next, especially in the midst of COVID, but we know the UK will finish its Brexit transition phase at the end of 2020.  It will be extremely disruptive to the European economy in general and the UK in particular.  Here are the two most likely scenarios at this point:

  1. The best-case scenario for the future trading relationship is now a rudimentary trade deal (formerly considered the worst-case scenario).
  2. The alternative is that the trading relationship defaults to World Trade Organization (WTO) terms on January 1st (now considered the new worst-case scenario).

Interestingly, back when the UK voted to leave the EU in 2016, a rudimentary trade deal was considered the worst-case scenario and exiting on WTO terms was not really an option at all due to the disastrous consequences.  Recent developments now make a hard Brexit on WTO term the most likely route forward. Here’s why.

Britain left the EU after signing a withdrawal agreement, which required it to follow EU rules during a transition period this year. Over the course of 12 months, the two sides were supposed to agree on the outline of what their new economic relationship would look like.  Instead, the UK government recently shocked the EU and some of its own citizens by further breaking down its already tenuous relationship with the EU. This has raised the risk of a hard Brexit, the worst-worst case scenario that seemed unthinkable four years ago.

Britain wants to set a lot of its own rules, especially when it comes to state aid, the biggest roadblock in negotiations. Instead of following the EU’s pathways, which would have provided better market access to British businesses, the UK now intends to follow WTO state aid rules.

On top of that , the UK Parliament is currently considering a bill that suggests it wouldn’t implement dual customs for Northern Ireland, which would lead to customs checks and a hard border between Northern Ireland and the Republic of Ireland.  That was also unthinkable at the onset of Brexit.  An outcome that undermines the Good Friday Agreement of 1998 that ended decades of violence in Northern Ireland would be a political and economic nightmare. Right now, people and goods flow freely across the border between them in significant numbers. There are close supply chain links between the two sides and all of that would be completely disrupted.

Here’s how this could affect all of us.  Reneging on prior commitments would jeopardize the UK’s reputation as a reliable negotiator in future trade deals with other countries like the United States.  In fact, US presidential candidate Joe Biden suggested he wouldn’t agree to a treaty with the UK if the border issue with Ireland isn’t resolved in a satisfactory way.

On top of that, British and European car manufacturers who were already struggling amid COVID have warned about what a no-deal Brexit would mean for their businesses. Under WTO rules, car and truck exports would be subjected to 10% and 22% tariffs respectively, translating to a combined £100 billion loss by 2025 for the automakers. The British farming industry, which accounts for two-thirds of British exports to the EU, will face even higher tariffs. On average, dairy products will be subjected to 35% tariffs. British firms would be forced to initiate the costly task of re-aligning supply chains.

Oxford Economics estimates that the U.K. will experience a slower recovery from the current slump with a no-deal Brexit, with real GDP 0.9% below its baseline at the end of 2022. The UK government’s analysis showed that a no-deal Brexit would reduce UK GDP by 7.6% after 15 years compared to a 4.9% decline if a free trade agreement be reached with the EU.  In any case, any good that we import from Britain and Europe will likely be subject to new tariffs that may inflate their prices for consumers.

The UK government is already under pressure because of how it’s handled the COVID outbreak.  A no-deal Brexit would compound the consequences just as the government prepares to wind down stimulus measures. Although the immediate shock from Brexit will likely be lower than the losses from the pandemic, it will almost certainly have an ongoing impact on the economy for several years to come.

 

 

Disclaimers and Notes
The views are those of Victoria Bogner and should not be construed as investment advice.  All information is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy.  All economic and performance information is historical and not indicative of future results. 

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