United Kingdom Politics June 2017

United Kingdom

United Kingdom: Hung parliament fuels hopes of softer Brexit as negotiations begin in earnest

June 23, 2017

The result of the 8 June general election, which saw Theresa May’s Conservative Party lose its absolute parliamentary majority and be forced to lean on the Democratic Unionist Party (DUP) in order to govern, has likely increased the probability of a slightly softer exit from the European Union.

The shock result has changed the balance of forces within British politics; the Prime Minister arguably didn’t receive a clear mandate from voters to pursue her vision of Brexit, which involved prioritizing a curtailment of European immigration. At the same time, the pro-EU Chancellor Philip Hammond, who before the election was widely considered to be about to lose his job, has remained in his post and emerged fortified. At the recent Mansion House speech, the Chancellor called for a “comprehensive agreement for trade in goods and services” and highlighted the importance of brokering a transitional arrangement before a final trade deal is struck, contrasting starkly with the Prime Minister’s past remarks that “no deal is better than a bad deal”. The Labour Party, which has also been reinvigorated by the election and now has greater clout in Parliament, is in favor of placing greater emphasis on establishing strong trading links with the EU; party leader Jeremy Corbyn has repeatedly called for a “jobs first” Brexit.

British firms have also become emboldened since the election, with five business organizations recently arguing in a joint letter for tariff-free trade in goods, “minimal” customs formalities, harmonized regulations and the easy transfer of labor between the island and the continent. The letter also underlined the vital importance of an interim deal, in order to anchor confidence in the economy and provide greater forward visibility to companies operating in the UK. Any Brexit agreement which focuses more on trade integration than quashing immigration is likely to be beneficial for the British economy, which is highly interconnected with the rest of the European Union and relies on foreign labor to plug skill gaps in the UK labor market.

A transitional arrangement is likely to be all the more necessary, given that the UK and EU negotiating teams agreed at the first formal Brexit meeting on 19 June to hammer out the terms of separation before discussing commercial relations. This leaves precious little time to finalize a trade deal before the UK leaves the EU in March 2019. Although there is likely to be substantial common ground on the issue of citizens’ rights, agreeing on a financial exit settlement could prove more arduous. The longer talks on the exit terms drag on for, the more likely it becomes that firms will deter investment in the UK and enact contingency plans to move some operations to the continent. This would have a detrimental effect on domestic demand, which is already looking shaky due to higher inflation dampening private consumption.

Although the election has caused the pendulum to swing slightly away from clamping down on immigration towards ensuring more frictionless trade, the UK is still on course to leave both the Single Market and the Customs Union. The Conservative Party has been clear in this regard, and although the Labour Party and the DUP have been slightly less forthcoming, neither party is proposing that the UK remain a part of either structure. This would inevitably lead to the reestablishment of some form of tariff and non-tariff barriers between the UK and the EU, however limited, which would reduce British economic activity and hamper export-oriented firms.

On the domestic front, the election result hasn’t resulted in a significant shift in policy making. The Queen’s Speech on 21 June, which sets out the government’s legislative agenda for the next two years, made clear how much of Parliament’s time will now be occupied by Brexit; no fewer than 8 of the 27 bills presented were Brexit-related, with no new significant domestic tax and spending commitments. As Chancellor Philip Hammond recently reiterated in the Mansion House speech, the government remains committed to eliminating the budget deficit by the middle of the next decade.

One key question, which could affect both Brexit negotiations and domestic policy decisions, is whether the new government will be able to go the distance. The agreement between the Conservatives and the DUP has yet to be finalized, and it isn’t certain whether the deal will resemble a mere “confidence and supply” arrangement or a full-blown coalition. The former, which would involve the DUP backing the government in no-confidence votes and supporting key legislation, could prove more unstable. In addition, there are already doubts over how long Theresa May can continue as leader of the Conservative Party. A change of leader midway through the parliament could possibly lead to another general election, heaping more uncertainty onto an already highly shaky political panorama and unnerving investors.

The Central Bank expects the economy to expand 2.0% in 2017 and 1.6% in 2018. This month, FocusEconomics’ panelists have upgraded their GDP projection for 2017 and our Consensus Forecast now foresees 1.7% growth—unchanged from last month’s estimate. The Consensus Forecast shows GDP expanding 1.3% in 2018.

Author:, Economist

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