Update on Brexit

The UK referendum to leave the European Union kicked off a multi-year process of negotiations and transition with many areas of risk to the final Brexit outcome and prospects for the UK economy. With the second phase of Brexit negotiations having recently commenced earlier this month, it is a good time to take stock of the current state of the Brexit process, evaluate what has been achieved so far and look forward to what we can expect in the coming months.

For the most part, 2017 was a year characterised by instability and uncertainty rather than substantial Brexit progress. This was headlined by the snap UK elections called by Prime Minister Theresa May in June, an effort to strengthen her mandate and negotiating position following the formal commencement of the Brexit process in March. This attempt to bring more stability to the Brexit process backfired dramatically, with May’s Conservative Party losing its majority, finding itself in a hung parliament and negotiating to form a Conservative-led minority government with Northern Ireland’s Democratic Unionist Party (DUP). This left Theresa May’s leadership in a precarious state, with little unified support from within her party, and opening her up to further doubt and criticism from the opposition and wider population – not a desirable position from which to embark on the Brexit negotiation process.

In addition, May’s government struggled to show unity on issues such as the UK’s payment of EU obligations (the ‘Brexit bill’) and migrant rights, which had to be settled with the EU before Brexit negotiations could proceed to the main phase of determining the UK and EU’s future post-Brexit relationship. However, the end of 2017 was a bright spot for initial withdrawal negotiations, with the UK and the EU agreeing on the broad principles of the withdrawal terms, particularly surrounding issues such as the Brexit bill, the Irish border and the rights of EU migrants residing in the UK.

With this first phase of negotiations successfully completed, the UK and EU have now moved to phase two of the negotiations, covering the post-Brexit transition period and the outline for the long-term UK-EU relationship. Transition negotiations involve working out a framework for the immediate post-Brexit relationship between the UK and EU. With the Article 50 process allowing only 2 years for leaving the EU, the Brexit date of 29 March 2019 is fast approaching, leaving insufficient time to determine all details of the long-term post-Brexit relationship, such as a comprehensive trade deal. Therefore, to avoid a hard Brexit, the UK and EU are working to agree on a transition period, of possibly up to a few years, where some existing arrangements could be maintained while the parties finalise details on the trade deal (and at which point the UK could also form free trade agreements with other countries).

What this transitional period might look like remains up for negotiation, with a few key issues at play. Draft negotiating guidelines from the EU27 (ex-UK) require the UK to abide by the EU body of law through any transition period, including new laws made without the UK’s input, something UK negotiators may find difficult to accept. The EU’s guidelines also propose the transition period lasting until the end of 2020, whereas the UK is seeking a longer or more open-ended transition period.

The first round of negotiations of this second phase of talks began in early February, and both sides will be keen to agree on transition arrangements as soon as possible (likely by the March European Council meeting), to give certainty that the UK won’t fall abruptly out of the EU in March 2019, and to clear the way for negotiations on the broader principles of the long-term relationship. The EU is expected to release draft guidelines for the future long-term relationship at the March European Council meeting, and will hope to agree on the broad principles of this relationship before the October or December Council meetings. However, there are no guarantees that the parties will agree on all these matters within these tight timeframes, and the EU can block negotiations from progressing from transition negotiations to the long-term relationship negotiations if they don’t believe sufficient progress has been made.

The longer negotiations remain unresolved, the greater the risk of a hard Brexit come March 2019, where the UK would revert to World Trade Organisation rules and see an abrupt imposition of tariff and non-tariff trade barriers. This would be a great cost to the UK economy, with UK government analysis suggesting a hard Brexit could wipe as much as 8 percentage points off growth over the next 15 years. Our central case is that the UK will negotiate a transition period and subsequent free trade agreements, limiting long-run damage from Brexit to around 2½-3ppts from GDP. In the meantime, uncertainty around Brexit will continue to weigh on growth and investment, and we expect growth to average a subdued 1.7% annually over 2018 and 2019. However, the progress of Brexit negotiations will continue to be a key source of risk in our view on the prospects of the UK economy.

Table 1: Financial market movements, 15 - 22 February 2018

Equity index



10-yr government bond



Foreign exchange



S&P 500





1.1 bps

US Dollar Index (DXY)



Nikkei 225





-1.1 bps




FTSE 100





-10.0 bps









-5.8 bps




S&P/ASX 200





-4.5 bps




 Source: Bloomberg


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