Divorce papers for Brexit are out

Finally. London has revealed the British government's commitment to negotiations with the EU on how to split up.  

What strategy will the United Kingdom (UK) adopt in the negotiations on its withdrawal from the European Union? That was a big unknown since the referendum on the other side of the channel on June 23 last year. Many companies, among others, were eagerly waiting for clarity in this area. After all, a lot depends on the answer.

If the UK is heading for a so-called 'hard Brexit', British companies will have to prepare for stricter immigration laws, for example. The free movement of people between the EU and the UK will then be canceled in the event of a hard Brexit. However, there are also consequences for the movement of goods and services between the two blocks.

Indeed, 'Brussels' has said loud and clear that the UK should not count on abolishing the free movement of persons, but on maintaining free access to the EU market. In other words, if the British want to ensure that their companies can freely sell their goods and services in the EU, they must accept the free movement of people between their country and the EU.

For a long time the government in London did not want to provide insight into its own negotiating position. However, the pressure to indicate how the country wants to split up has grown to such an extent in the UK that Prime Minister Theresa May could no longer refuse to disclose.

Today she laid the British cards on the table. Indeed, the UK opts for a hard Brexit, that is, the country states that it will be able to control its borders and immigration completely and independently over free access to the common EU market. As Prime Minister May said: 'To stay in the common market means in fact that we are not leaving the EU. We don't feel like being half inside and half outside the EU.'

The United Kingdom now wants to conclude trade agreements with other countries, such as the US, as soon as possible. Donald Trump, who will be sworn in as the new US president in two days, recently said in an interview that he would like to conclude such a treaty with the UK soon. Other countries are also queuing up to do business with London. Until now, the UK was covered by trade agreements that the EU had with other countries.

Some analysts expect the United Kingdom on its own to be able to conclude trade agreements more quickly with those countries with which the EU does not yet have such a treaty. We have to think of countries such as Australia (British commonwealth) but also a very large part of Asia, including China.

This choice therefore means, as mentioned, that as soon as the separation is final, British companies can no longer just sell their goods in the EU countries. But the reverse also applies: companies from EU countries have to take taxes and other cost-increasing obstacles into account if they want to sell their products to the British. In order to regulate trade between two blocs, the UK and the EU will conclude a kind of trade agreement in the near future to regulate mutual trade. Experience shows that this is an extremely complex and lengthy process.

Please note: the above will only take effect when the UK actually leaves the EU. Until that is the case, the country will simply be a member of the EU and British companies will have unimpeded access to the European common market and vice versa. The divorce is expected to be finalized in early 2019. Until then, the situation will remain unchanged. Although… one important aspect has already changed, with huge benefits for UK companies and equally significant drawbacks for companies from the euro area.

On the eve of the British referendum, the EUR/GBP exchange rate stood at around 0,77. The exchange rate is now around 0,87 or: the British pound has weakened by about 15 percent against the euro.

For British companies, who sell their goods and services in the euro countries, that means they can cut their price by 15 percent in one fell swoop and still make the same profit per product as before. From the Eurozone's point of view, this means that competition from the UK has become significantly fiercer. In our own country, but also in the UK itself, since everything that companies from the euro countries sell there for the British, expressed in pounds, has suddenly become 15 percent more expensive. In order not to see sales fall, eurozone companies often have to make significant price cuts, with all the consequences for profits.

However, the pound has also fallen sharply against the dollar, which means that those companies from the euro countries that have to compete with British companies in other markets in the world outside Europe, also see their competitive position deteriorate. After all, the dollar is often the currency in which international trade is settled. Something that gives UK companies a significant cost advantage thanks to the weak pound. 

Finally, there is one more factor that both businesses and consumers in the EU must take into account for the coming years. The United Kingdom contributed almost €10 billion net to the EU budget every year. There are already noises in Brussels about those revenues that will disappear – we will not pay a cent more to the EU, Prime Minister May mentioned as one of the 'red lines' in the negotiations on the aforementioned separation between the EU and the UK – simply compensate by skimming more money in the remaining EU countries. There is a good chance that the Brussels administration will indeed not shrink by approximately 10 billion, but that companies and households in the EU countries will directly and indirectly pay more taxes and levies in order to maintain EU finances. 

Edin Mujagic

Edin Mujagic is a macro-economist and chief economist at OHV Asset Management. He focuses on global central banks, and in his blogs he mainly writes about the ECB and Fed. He has also written several books.

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