AXA IM: Comment on the UK’s Brexit Withdrawl Deal

15 nov 2018

It is this last component that has proved most contentious and whose recent ‘resolution’ allowed a ‘break through’ in negotiations. 

In an accompanying non-binding “political declaration” on future relations, the EU and UK agree to work towards a long-term commitment of an ambitious free trade agreement (FTA). However, as recent negotiations have shown, there is little prospect that a FTA (now or in the future) will be able to address the commitment to “no border” in Ireland. As such, the Withdrawal Agreement includes a legally binding ‘backstop’ agreement. This would see the UK enter into a regulatory customs union with the EU (after transition) until an alternative arrangement is in place. This ‘backstop’ is highly likely to form the basis of relations in the future. Alongside this, the UK has made associated commitments to a “level playing field” where it has undertaken not to “regress” on standards on social, environmental and labour regulations. Moreover, this arrangement will remain in place until both sides agree it is no longer needed. This removes the UK’s unilateral right to exit such an arrangement. It also alters the EU’s incentives as it negotiates any future trade arrangements.

That said, the backstop customs union is not fully-formed as it currently stands. The UK would not be part of a common regulatory regime for EU goods (as envisioned under the Chequers proposal), it would not include road transport agreements (inhibiting UK hauliers access to Europe) and it would not include agreements necessary for agri-food products. By contrast, Northern Ireland would have unique arrangements to facilitate the smooth transition of goods across this region, including for the important agri-foods trade (above and beyond the unique standards and separate checks already in place in Northern Ireland). The Agreement states that such a ‘backstop’ is designed never to be used. To this end, the Agreement also adds an option (to be exercised in June 2020) to extend the transition arrangement (for a ‘limited’ period). We also see this option being exercised.  

The economic benefits of the Withdrawal Agreement are obvious. The deal provides a transition phase of at least 21-months, which would avoid an abrupt rupture from the EU in March next year. The IMF recently estimated that the long-term consequences of a reversion to WTO trading could reach 8% of GDP, but that even this assumed a transitional exit, without which exit could be more severe, including a “sharp fall in asset prices” and a “hit to consumer and business confidence”. By contrast, a deal that would avert such an abrupt rupture and avoid an unprecedented supply-side shock (which we estimate would result in recession)