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Brexit is not done yet

Many expected the UK Government would soften its stance on finalising a post-Brexit EU trade deal by the end of the year when Coronavirus started to take its toll on the UK economy three months ago.

The EU Withdrawal Agreement stipulates that the current transition phase, during which the EU trade rules still  apply to the UK, terminates by 31 December 2020 and will be replaced either with a free trade deal or with a World Trade Organisation (WTO) arrangement, which means a no-deal scenario. However, the UK Government has the option to extend the transition phase by up to two years if it applies for an extension by the end of June.

It has become apparent in the last few weeks that the UK Government is not planning to file for such an extension and is pressing ahead with finalising the trade negotiations by the end of this year. The main argument for this position is that the UK economy will be reshaped by the current crisis as companies create new supply chains and repatriate production for greater resilience of the economy in the future. To deliver such change the Government believes it requires the level of independence that only an exit from the EU trading structures can provide, which it aims to achieve by the end of the year. Given the short time available to agree a free trade deal, this might mean that the negotiations are compromised and will not provide the desired outcome.

The draft text proposes zero tariffs and zero quotas on goods and includes relatively loose ‘level playing field’ provisions.

No-deal uncertainty remains

By pressing ahead with a definite deadline by the end of 2020, the negotiations will conclude with either a UK/EU free trade deal or with no deal. The uncertainty that a no-deal scenario continues to create for the economy has urged large international manufacturing companies, like Nissan and BMW, to warn in recent weeks that a hike in post-Brexit tariffs on goods as a result of a no-deal would make manufacturing in Britain for other export markets not viable anymore. Studies by the CBI have suggested that a no-deal Brexit would hit the UK manufacturing economy hard and risks the loss of tens of thousands of jobs in 2021.

The focus on both sides of the negotiation table is to agree a deal. On 19 May, the UK Government published a draft FTA text which will form the basis of the negotiations with the EU in the months to come. The draft text proposes zero tariffs and zero quotas on goods and includes relatively loose ‘level playing field’ provisions. The EU’s expectation is, however, to have an overall governance framework as part of the FTA that covers all areas of economic and security cooperation and is enforceable with the European Court of Justice as the sole arbiter of EU law.

The major sticking point on the EU’s side is to agree a ‘level playing field’ which would require the UK to apply the EU rule book on competition law, workers rights and state aid provisions. The UK Government believes that such close ties to the EU rules would limit its ability to strike future trade deals with other global economies. A compromise in this area might see the UK allow more generous access to its fishing waters in exchange for looser ties with the EU rule book. This is an important area to watch in the weeks to come since it will define to what degree the UK economy will be shaped by changes to wider EU policies in future.

Germany’s round for EU presidency

From 1 July, it will be Germany’s term at the head of the EU’s rotating presidency, which might bring the required nudge for the negotiations to successfully conclude. The presidency will be Angela Merkel’s final round of major political involvement on EU matters before she steps down as the head of the German Government after 16 years in 2021. A no-deal Brexit would be catastrophic for the German export economy, which sees the UK as its largest European trading partner. The speed of Germany’s economic recovery from Coronavirus will very much depend on how quickly foreign export markets recover. A no-deal Brexit would mean a huge blow for Germany’s struggling export economy and it is not in Merkel’s interest to leave the political stage with a catastrophic outcome for the German economy. If social distancing measures allow by then, we might see a lot of Johnson and Merkel after the summer break to hammer-out a last-minute trade deal.

This bare-bones trade deal will be far from the level of detail that the EU has recently agreed with other major economies.

US presidential elections

The US elections on 3 November could also bring a late twist to the EU negotiations, which are planned to conclude in the last week of November to allow enough time for the EU’s complex trade deal ratification process to take place in December. Most of the UK Government’s confidence in the Brexit negotiations has been based on the assumption that free trade deals with other major global economies can be agreed quickly after Brexit, above all with the United States. The Trump administration has been in favour of concluding a basic UK/US trade deal soon and could be concluded in early 2021, once the UK has left the EU trading structures. However, in the event of a change in the US Government later this year, the process could be delayed or completely reshaped, increasing the pressure on the UK Government during the last round of negotiations in November to agree on a deal with the EU.

A cautious prediction

Considering all of the above, a cautious prediction could see the UK not falling off a cliff-edge on 31 December and agreeing to a bare-bones UK/EU free trade deal, which is limited on reducing friction of how goods move between the UK and the EU from 1 January 2021. This is simply to avoid chaos for supply chains at a time when European economies are slowly recovering from the current crisis and to allow for essential goods, such as food and drugs, to cross the channel without additional burdens, such as expensive tariffs. However, this bare-bones trade deal will be far from the level of detail that the EU has recently agreed with other major economies, such as with Canada or Japan. Negotiations will continue in the years after December 2020 and gradually add further sectors to the trade deal to optimise how the UK and EU will trade in future, similar to how the EU has been agreeing a closer relationship with Switzerland over the past 15 years.

Demand for information remains high and businesses should continue to prepare for all outcomes – including a no-deal Brexit on 31 December 2020.

Alex Altmann, June 2020