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October 10, 2016

Waking up to the hardness of Brexit

It looks this morning that at least one opportunity for an electoral insurrection will be missed. The implosion of Donald Trump puts the spotlight back on Europe, the Italian referendum, the string of elections in 2017, and of course Brexit. 

Theresa May has done two things. She left no one in doubt that Brexit will happen, and that it will be a hard variant.

The flash crash of sterling has been interpreted as harbinger of the long-awaited economic backlash. We think this is a misinterpretation. We agree with Roger Bootle's analysis that the combination of a fall in sterling and a rise in inflation expectations in the UK are benign developments that will facilitate adjustment. It will, of course, reduce real wages further, but will contribute to rebalancing, and raise inward investment. Below are the latest inflation forwards. While in Q3 one can see a change from downward to upward trend in the 5y-forward 5y inflation rate if one squints, there has been a definite upwards spike in both that and the 2y-forward 2y inflation rate since the end of September.

Grep Ip makes a similar point in the Wall Street Journal. He notes the country's 5.9% current account deficit. He goes through the channels through which the lower sterling helps - foreign investment, rise in exports, and even addressing inequality if it benefits manufacturing at the expense of the City of London. Those who keep equating the fall in sterling to "bad news for Brexiteers" should not hold their breath.

Wolfgang Munchau notes in his FT column that it is smart to accompany a hard Brexit with a shift in macroeconomic policies. Brexit constitutes a Mancur Olson-type shock, one that weakens existing lobbies and industries, in this case the City of London, and allows a country to undertake a strategic economic shift. There is, however, an acute danger that Theresa May will mess this up by discriminating against those foreigners she may need the most in support of this endeavour.

As so often Charles Grant offers the most reliable assessment of where we are in the Brexit diplomacy. He writes in the Guardian that he was surprised to see on a recent visit to Brusels, Paris and Berlin how indivisible the four freedoms, and how united the position towards Britain, are. If Britain wants immigration control and being cut from the jurisprudence of the ECJ, then the UK will leave the customs union and the single market. He concludes that it is wishful thinking to believe that this is just an opening gambit. Grant makes an important point on a confusion that has arisen in the British debate about immigration. Just because Germans oppose immigration from Syria, this does not mean they take the same stance with the UK. Germans do not oppose intra-EU migration. In fact, they don't even call it immigration. Grant concludes that the only way to get a halfway decent deal is through goodwill. And the UK is losing this goodwill now.

And finally, we would like to draw attention to a comment by Niall Ferguson on the Times. He writes about the following extraordinary statement from Theresa May's speech, which may characterise her approach to government in the coming years.

"If you believe you are a citizen of the world, you're a citizen of nowhere. You don't understand what the very word 'citizenship' means."

He writes he is one of them, and he believes that he and other global citizens are about to lose the battle. The UK is now heading for a hard Brexit. The free market ideology of Margaret Thatcher is now profoundly repudiated. And most breathtaking of all is her promise of a new industrial strategy.

The Guardian, meanwhile, reports that the British government wants to shift the immigration controls that would otherwise have to be erected at the intra-Irish border on Brexit, to Ireland's external ports or airports. That would solve one specific problem if Ireland - and presumably the EU as well - co-operates. But this approach is not a blueprint for the much bigger problem of where to erect the customs post between Britain and Ireland on Brexit.

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