A very recent study commissioned by the Bank of England titled, “The Impact of Brexit on UK firms”, and which is based on a new survey of UK firms, highlights the high level of uncertainty introduced by the Brexit process since the referendum of June 2016. Although Brexit uncertainty has not significantly lowered employment across the country, its impact on a range of other processes was significant.
The study found that 50% of firms considered Brexit to be one of their top three drivers of uncertainty, which has increased substantially after the September 2018 Salzburg summit, when the EU rejected the UK’s Brexit plan. Moreover, the same study found, since June 2016 investment was reduced by 11%, whereas the reduction of productivity ranged from 2% to 5%.
The Brexit extension of 31st October 2019 agreed by both the EU and the UK increased the level of uncertainty instead of reducing it. On this basis, one could argue that exiting the EU on Halloween with or without a deal is paramount as it will settle the issue of uncertainty for the benefit of the British people and companies. However, we have reasons to believe that uncertainty may well persist long after Brexit, especially if there is no deal. Let us explain why.
No deal Brexit (henceforth: NDB) means that Britain will revert to WTO rules to trade with the EU and the rest of the world. This is likely to reduce trade with the EU by 40%. Note that some 44% of all UK exports go the EU and 53% of all of its imports come from the EU (import of foodstuff from the EU is around 30%). As 63% of the UK’s economy is made of trade, the shock waves following a NDB are likely to persist. But there is another reason for the extension of uncertainty beyond the Halloween.
The British economy is extremely financialised. Manufacturing, once a powerful component of the country’s GDP, has fallen to below 11%. True, manufacturing is in retreat everywhere in the West, although we should point out that Germany has kept its manufacturing base (German manufacturing is over 21% of GDP). Britain’s city financial centre is the largest financial hub in the world employing more than 2.2 million people (we include all related professions and services dependent on the city). The uncertainty impacting financial firms is of a different type than that of the real economic sector. Two issues matter here.
The first has to do with the investment banking, clearing and asset and equity management, including currency swaps and equity and derivatives trading. Some £40bn to £50bn of this type of services relate to EU markets, but some £55bn to £65bn are truly global and do not depend on the EU. Thus, some 50% of trading exchange is conducted in Euros and the City of London is the largest hub in the world for Euro-trading and various currency swaps.
It seems that the co-dependency between the UK and the EU is such that both parties have an interest in a mutually convenient deal that continues the present state of affairs. However, and this is the second issue, there is a long and protracted friction between the city and Brussels, which regards the degree of regulation imposed on the city by the EU.
UK regulations are very few and concern mainly some fundamental ring-fencing. On the contrary, EU regulations are many and rather rigid: market abuse directive, LIBOR regulation, solvency, payment services directive, EU infrastructure regulation, the list is long enough.
Hedge funds, although not the bulk of the city’s trade and activity, are extremely hostile to regulation and their business are global. The tension between the city’s financial firms and the EU on the issue of regulation is real. The city aims at diversifying trading relations and boost business with Asia.
The EU aims at developing a self-reliant and integrated capital market, based on excessive regulation, which is typical of the German model of the so-called “social market economy”, which has been transplanted in the EU and its member states via the Treaties. Herein lies the reason of the toxic fight about “passporting rights” and “market access” to the EU and vice versa, a fight that has been extremely politicised, especially in the UK’s political scene.
In sum, for all the above reasons and to the extent that “we can predict the future”, we believe that uncertainty and tension between the UK and the EU will continue beyond Halloween in the event of a NDB. At the same time, it is clear to us that, both sides, have a vested interest to reach a deal and create an economic and political atmosphere that respects the referendum result of June 2016 and consolidates social and politico-economic stability in the UK and beyond.