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June 27, 2016

... 'twere well it were done quickly

It was a weekend of unbridled anger and confusion in British politics. Anger is the second phase of mourning. The first is denial, which was the predominant mindset throughout the campaign. The Remainers were unbelievably complacent. It will take some time until we reach the next stages of bargaining, depression and acceptance.

The best commentary on what happened is Charles Grant's. Grant, who supported Remain, admits that Leave had the better salesmen. Boris Johnson and Michael Gove, both former journalists who have turned British politics upside down, have been extremely effective. He also argued that the Remain supporters made too much of the economic arguments:

"As the government piled on more and more forecasts of doom and gloom, it laid itself open to the charge of scare-mongering. By the end of the campaign, a lot of people simply didn’t believe what the government said about the economy, and they didn’t want to hear more statistics."

Another even-headed analysis was Kevin O’Rourke's observing the profound depression of his friends in Oxford, the impact of the vote on Ireland, and what the EU should do. We agree with his conclusion that the EU should offer the UK a fair deal.

But these were the exceptions. There was a lot of historical hyperbole (the worst since Eden, an so on). Economists are particularly angry because they have been ignored, something that hasn’t happened to them in a long time. We noted that Kenneth Rogoff started an article with "The real lunacy of the United Kingdom’s vote…", demonstrating a complete lack of understanding or respect for democratic decisions. At Eurointelligence we always complained about the economic illiteracy of Europe’s political class. But this is nothing compared to the political illiteracy of economists.

So, what is going to happen now? Forget the petition for a second referendum. It is not going to happen. We would also caution against any attempt to sabotage the result by other means – like a refusal by the parliament to ratify. Any political party that ran election campaign on that premise would risk total annihilation. The will of the voters will be respected. Even the LibDems say this, and they have no eurosceptics among them.

The path is muddied by the coming political upheavals in domestic British politics. Both the Conservative and Labour parties will now go through an unprecedented process of convulsion. After Cameron's resignation there is now an attempt to stop Johnson becoming prime minister. And the parliamentary Labour party is in open revolt against Jeremy Corbyn. That revolt may not succeed because Corbyn could stand again and get re-elected. But anything is possible. Our working assumption is that the Tories will replace Cameron with a candidate who supported the Leave campaign. We don’t think it is necessariy going to be Johnson. The Tories will win, or there may be a coalition with the LibDems, who knows? But Art 50 will then have to be triggered.

The European Council will play ball for the moment. Forget the posturing by Martin Schulz and Jean-Claude Juncker. Angela Merkel will prevail in the European Council with her acceptance of a small delay in the triggering of Art 50. Small delay means a few months, until the end of the year at most. But even she will not accept a further delay. The best bet for Britain would be to stay in close contact with Merkel, who is their best ally right now.

Do not, however, underestimate the impact of this vote on the other member states. Art 50 is vital for François Hollande because an indefinite delay would favour the election chances of Marine Le Pen. In any case, we think that the vote in the UK has dramatically increased the risk of an electoral victory for both Donald Trump and Le Pen, because it demonstrates that insurrections happen elsewhere, and that they can succeed. If Britain were allowed a soft EU opt-out, done unilaterally through the House of Common and without invoking Art 50, we would expect Le Pen to win the election on a promise to follow the British example. Hollande will thus block such an outcome. The compromise will thus be a time-limited delay. We think this would be very sensible.

Also consider the economic impact. We always accepted the argument of a short-term economic impact because investors don’t like uncertainty. That uncertainty will continue for as long as there is no clarity about the path ahead. The smart strategy for the next government would be to co-opt the EU into a  very quick agreement. It's all in Shakespeare's Macbeth: "if it were done when 'tis done, then 'twere well it were done quickly." We will not go into the specifics in our briefing today. But the only two viable options are the Norway or the Canada agreements – or something in between.

It is our assessment that the economic impact will be more negative for the EU than for the UK. We noted that the Milan stock exchange was down 12% on Friday, while London was down only 5% - a surprisingly mild reaction. But the impact of Brexit could be devastating on the eurozone. The country to watch out for is Italy, where we expect the next big crisis to happen. See Wolfgang Münchau's columns in the FT and Corriere della Sera this morning. He argues in the FT that, if Matteo Renzi loses his referendum on constitutional reforms in October, Italian politics will become unstable. Brexit is hitting the already anaemic Italian recovery. And the banking system is woefully undercapitalised. We noted that Italian readers are pointing out that the constitution does not allow a referendum on international treaties – in other words, no referendum on the euro. But if a party were to win an election questioning Italy’s membership of the eurozone, we think the game would be up. Economic and financial pressure would be intolerable in that case.

In his Italian column, Münchau makes the point that Brexit will have to lead to further political integration in the eurozone. At their meeting today, Renzi should stand up to Merkel, and demand immediate progress towards political and fiscal union. And Merkel should listen to him. While it is true that you cannot win German elections on a promise of political union, you cannot win them with economic chaos either. The political possibilities are shifting.

And finally, there is another catalyst that might speed things up. Jonathan Hill's resignation as commissioner for financial services is the first symbolic act of Brexit. Britain has lost the one portfolio it is interested in. His portfolio will be taken over by Valdis Dombrovskis while Jean Claude Juncker invites the British government to nominate another British commissioner.

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