The fallout from Brexit has just begun and it’s about to get a lot worse

PUBLISHED : Thursday, 07 December, 2017, 11:07am
UPDATED : Thursday, 07 December, 2017, 10:39pm

Spare a thought for investors in the volatile pound sterling.

At one point on Monday, the sterling rose above the US$1.35 level, as it seemed that United Kingdom Prime Minister Theresa May was about to reach an agreement with the European Union on the first phase of negotiations over the terms of Britain’s exit from the bloc.

Yet, as news trickled out that talks had broken down due to opposition to the deal by the May government’s partner, the pro-Brexit Northern Irish party, the pound took a knock, suffering its biggest fall against the dollar in three weeks.

Currency investors have been here before. Having plunged 15 per cent versus the US dollar in the four months following the Brexit referendum in late June 2016, the sterling bounced back this year, shooting up nearly 12.5 per cent between early March and mid-October partly because of growing confidence that Britain and the EU will reach a deal in their divorce.

Over the past several weeks, the pound has bobbed up and down like a yo-yo, as the clock ticks on, anticipating the securing of an agreement on the first round of negotiations ahead of a meeting of EU leaders on December 14-15.

But even if May does clinch a deal, the fallout over Brexit has only just begun.

For starters, the current negotiations pertain only to the size of Britain’s “divorce bill”, the rights of British and EU citizens living abroad and the UK-Irish land border. While a deal would pave the way for the two sides to conclude a transition agreement to smooth the exit process after Britain formally leaves the EU in March 2019, the toughest, and most politically contentious, negotiations lie ahead.

It is the second stage of talks covering Britain’s future trade relationship with the EU that will throw the bitter divisions within the UK political establishment - both the ruling Conservative and opposition Labour parties are rived with splits between parliamentarians who want Britain to remain as closely aligned with EU rules as possible and those who insist on a “clean” Brexit - into sharper relief.

The divisions over Brexit, moreover, are exacerbating the deterioration in the performance and outlook for the UK economy which in the first-half of this year was the slowest-growing in the G7 group of advanced economies and is set to expand at an average pace of just 1.3 per cent over the next three years, according to new forecasts from the European Commission.

This will put Britain’s growth rate on a par with Italy’s, long perceived as the “sick man” of Europe.

Not surprisingly, the economic downturn is proving fertile ground for populist policies, particularly given the squeeze on wages and disposable incomes which are expected to stagnate or fall in real terms over the next five years.

According to the Resolution Foundation, a UK think tank, British households face the longest sustained decline in living standards for 60 years. This is benefiting Britain’s opposition Labour Party whose firebrand leader, the left-wing Jeremy Corbyn, has won strong backing for his policies to renationalise utilities and pour billions of pounds into health, education and social care.

Corbyn’s anti-capitalist rhetoric, coupled with his pro-Brexit stance, are unnerving investors at a time when May’s government is in danger of collapsing and is struggling to reach an agreement with the EU.

In a much-talked-about note published last week, Morgan Stanley argued that the UK’s volatile political scene now poses a bigger threat than Brexit. It also suggested that “given the high likelihood” of another election next year, and the sizeable risk that Labour would win, Britain could be about to experience “the most significant political shift since the end of the 1970s”.

These are bold predictions which may well prove wrong. What is clear, however, is that the Brexit vote has opened a Pandora’s box of economic, political and constitutional problems for the UK which will only deepen in the coming months as the uncertainty over Britain’s domestic and international position intensifies.

According to a report by the National Centre for Social Research, a UK research agency, more than half of Britons believe the divorce proceedings with the EU will end badly. Even those supporting Brexit believe May is conducting negotiations poorly.

Still, if a second referendum were held today, the outcome would probably be the same as the first one: a slender majority in favour of leaving the EU.

Britain is deeply polarised, knee-deep in a political crisis and in the grip of a sharp economic slowdown. Managing Brexit will become more difficult with each passing day.

Nicholas Spiro is a partner at Lauressa Advisory

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