Brexit Monitor #27 Brexit negotiations set to start today what now? Senior Analyst Mikael Olai Milhøj +45 45 12 76 07 milh@danskebank.com 29 March 2017 Investment Research www.danskemarketsequities.com Important disclosures and certifications are contained on page 12 of this report.
PM Theresa May set to trigger Article 50 today PM Theresa May is set to trigger Article 50, see also Brexit Monitor #26: PM May to trigger Article 50 on Wednesday 29 March, 20 March. The Financial Times has a nice overview of the Brexit day and the following events. Brexit letter to the EU a few pages long (probably repeating PM May s 12 Brexit principles, see next slide). UK Cabinet to discuss the letter this morning (9:00 CET). PM Theresa May is expected to make a statement to Parliament on the triggering of Article 50 at 13:30 CET. Donald Tusk is expected to make a short statement shortly after receiving PM May s letter. EU Parliament set to make announcement tomorrow afternoon (Thursday, 30 March). Also tomorrow, the UK government is said to publish its white paper on the so-called Great Repeal Act, which repeals the European Communities Act 1972 and transforms current EU laws into UK laws (for more see Financial Times). Donald Tusk is expected to publish draft Brexit guidelines on Friday ( within 48 hours ) based on EU chief negotiator Michel Barnier s recent writings, the guidelines are likely focus on (1) the divorce bill, (2) citizens rights (both for Britons living in the EU and EU citizens living in the UK), (3) external borders (Ireland versus Northern Ireland). EU27 ambassadors ( sherpas ) to discuss draft Brexit guidelines ahead of extraordinary EU council meeting on Brexit on 29 April (discussing and possible signing off of Brexit guidelines). 1
PM Theresa May s 12 Brexit principles indicate a hard Brexit What PM Theresa May wants Important take aways from PM May s Brexit approach Parliaments get to vote on the final deal => May has accepted she needs to involve parliament. Control immigration and control of own laws. Leave the single market and likely the custom union. Aims at a comprehensive Free Trade Agreement with not just the EU but other countries as well. The UK wants a transitional deal to ensure a smooth, orderly Brexit. The UK will not contribute huge sums to the EU budget. The UK will change its economic model (lower corporate taxes and deregulate significantly) if the EU tries to punish the UK. EU letter to reflect May s 12 Brexit principles 12 Brexit principles Provide certainty about the process of 1 leaving the EU 2 Control of own laws 3 4 Strengthen the union between the four nations of the UK Maintain the Common Travel Area with Ireland 5 Control of immigration coming from the EU 6 Rights for EU nationals in the UK and British nationals in the EU 7 Protect workers' rights 8 Free trade with European markets through a free trade agreement 9 New trade agreements with other countries 10 The best place for science and innovation 11 Co-operation in the fight against crime and terrorism 12 A smooth orderly Brexit Source: UK PM Theresa May s speech 2
The EU s negotiation stance According to the EU s Chief Brexit negotiator Michel Barnier (see Financial Times), the UK and EU need to find a solution to the three following things before moving on to discuss the future relationship 1. Divorce bill (which EU estimates to be around EUR60bn) 2. Citizens rights (both UK citizens living in EU and EU citizens living in the UK) 3. External borders (Ireland vs Northern Ireland) Barnier writes If we cannot resolve these three significant uncertainties at an early stage, we run the risk of failure. The EU and UK need to agree on an orderly withdrawal of the UK before negotiating any future trade deal. Previously he said that (1) EU27 will be united, (2) the UK cannot get a deal which is better than full membership, (3) the UK cannot get full access to the single market if it does not accept the four freedoms (free movement of goods, services, capital and people). Cherry picking is not an option. Donald Tusk is set to publish draft Brexit guidelines within 48 hours of the UK triggering Article 50. Guidelines expected to reflect Barnier s three points. Extraordinary EU council meeting is held on 29 April. Source: Reuters and Financial Times 3
Our base case The UK and EU will probably have to negotiate about how to negotiate after the triggering of Article 50. Due to the ratification process, a deal (or at least a transitional deal) has to be reached by October 2018 the latest. The UK is set to leave the single market and the custom union, as staying within means it cannot make free trade deals with other countries. It is unlikely that a full deal can be reached within the two years of negotiations so the UK and EU are likely to agree on a transitional phase, especially for exposed industries such as autos, agriculture and financial services. The UK has ruled out contributing significantly to the EU budget, which may create tensions among EU27, as the UK is one of the biggest net contributors to the EU budget. This is one of the UK s best negotiation weapons. In our base case, the final deal will be something similar to the EU-Canada CETA deal, which reduces/removes trade barriers for goods but remains weak on service. The UK is set to lose passport rights for banks. Risk of a so-called cliff edge Brexit with no agreement has increased, as May has said that no deal is better than a bad deal. We think that the risk is highest at the beginning of the negotiations due to disagreement on the divorce bill. While the EU wants to settle the divorce bill first before discussing the future relationship, the UK wants to discuss both simultaneously we are likely to see negotiations about how to negotiate at the beginning and the risk of no deal seems to be the highest here. 4
Brexit timeline Vote in House of Commons (13 Mar) BoE meeting (16 Mar) UK to trigger Article 50 (29 Mar) Donald Tusk to publish Brexit guidelines within 48 hours after, possible on Friday (31 Mar) BoE meeting (11 May) 1 March 2017 EU council meeting (9-10 Mar) Dutch election (15 Mar) Eurogroup meeting (20 Mar) EU summit (25 Mar) Eurogroup meeting (7 Apr) French election, 1st round (23 Apr) Brexit EU summit (29 Apr) 1 May 2017 French election, 2nd round (7 May) The full process could take several years EU vote May s hard Brexit speech 2 years to negotiate the terms of withdrawal cf. Article 50 of the EU Treaty UK formally exits EU Further negotiations, implementation/ transitional phase 23 June 2016 1 January 2017 Source: EU Treaty, Danske Bank Markets End of March EU laws still apply in the October 2018 UK during the withdrawal negotiations Negotiations have to be concluded before Oct-18 due to ratification process April 2019 European elections: France: April/May 2017 Germany: 24 September 2017 Italy: Before Spring 2018 European Parliament: May 2019 UK general election: May 2020
Signs that growth is slowing in the UK PMIs have declined in Q117 Retail sales have plunged Source: Markit Economics, ONS Source: ONS 6
Consumers have become more pessimistic Business confidence has rebounded More widespread pessimism on Brexit impact 0 Jul-16 Aug-16 Nov-16 Mar-17-5 -10-15 -20-25 Net balance of optimists less pessimists (excludes don't knows) Source: Lloyds Bank, GfK Source: Markit Economics, IHS (House Financial Index, March 2017) -30 7
Significant GBP depreciation to push up import prices Weaker GBP implies higher import prices Inflation is moving higher to peak around 3% Source: Bloomberg, Macrobond Financial, Danske Bank Markets Source: ONS 8
Higher commodity prices also contributing to higher inflation From food deflation to food inflation Contribution from higher oil price has peaked Source: Bloomberg, Macrobond Financial, Danske Bank Markets Source: Bloomberg, Macrobond Financial, Danske Bank Markets 9
Bank of England to stay on hold for a long time BoE maintains neutral stance: The Bank of England (BoE) made no policy changes at its March meeting and reiterated its neutral stance by repeating it could move in either direction, see also Bank of England Review: Maintains neutral stance with hawkish twist, 16 March. BoE to see through higher inflation We still think it is unlikely that the BoE will tighten monetary policy in a time of elevated political uncertainty but we think we need to see substantially slower growth and/or higher unemployment before easing becomes likely again. Note that the BoE reaction function has changed since the financial crisis: the BoE puts more weight on growth/unemployment relative to inflation. Source: ONS, BoE, Danske Bank Markets 10
Recent UK research Brexit Monitor #26: PM May to trigger Article 50 on Wednesday 29 March, 20 March Bank of England Review: Maintains neutral stance with hawkish twist, 16 March. Research UK: Brexit uncertainty set to prevail in coming years, 4 January. 11
Disclosures This research report has been prepared by Danske Research, a division of Danske Bank A/S ( Danske Bank ). The author of this research report is Mikael Olai Milhøj, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst's personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank's research policies. Employees within Danske Bank's Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank's Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates This report is updated on a regular basis. Date of first publication See the front page of this research report for the date of first publication. 12
General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ('Relevant Financial Instruments'). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank's prior written consent. Disclaimer related to distribution in the United States This research report was created by Danske Bank A/S and is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank A/S, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to 'U.S. institutional investors' as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to 'U.S. institutional investors'. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non-u.s. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission. 13