The Bank of England’s mea culpa
We applaud Andy Haldane, the chief economist of the Bank of England, for coming clean on his own and other economists' forecasts of Brexit. They have been terrible. Speaking in London, he admitted that the profession was now in a crisis after what he referred to as a "Michael Fish moment", after a BBC weatherman who in 1987 infamously predicted that there would be no hurricane in England - only a bit of wind in Spain. He said the reason for the error was the unexpected resilience of the UK consumer and the unexpected strength of the housing market. Unlike other economists, Haldane did not double down by predicting that the recession would come this year, but made the following observation instead:
“Right now there is a very interesting disconnect between what we read in the papers about the degree of political and policy uncertainty, which by any historical metric is at high levels, and what we have seen from the economy and financial markets, which have actually been remarkably placid. That disconnect cannot last forever. There will need to be a reconciliation between the two ... Maybe some of the scarier stories politically will be seen to be just that – scare stories. ”
Maybe that, or maybe the recession comes after all. We don’t know. Our own view is that the economic impact of Brexit is going to be rather small - a little bigger, but not dramatically so, if there is no Brexit agreement.
Right now the British economy is still roaring ahead. The latest Markit/CIPS purchasing managers' index for services went up in December to its highest level since July 2015, and employment expanded at the fastest level for seven months. More importantly perhaps, the future outlook also improved. Reuters reports that foreign demand for British government bonds also reached an all-time record level, as investors are hoping to gain from the low value of sterling.
One of the most critical issues for the economic trajectory over the next two to three years is whether the UK will be able to negotiate a transition deal, or whether it will leave the single market and the customs union at the same time. The FT has an article on Sir Ivan Rogers' resignation as Britain’s Permanent Representative to the EU, which says that the transitional deal kept him awake at night. We are not sure whether the various scenarios for a transitional deal are realistic - we think the most probable one is a time-limited transition period with the UK inside the customs union, but outside the single market and outside the jurisdiction of the ECJ.
The article makes two important observations. The first is that if there is no deal on an interim agreement by March 2018, a year before Brexit, the value of such a deal declines dramatically for the UK, as companies would at that point start to prepare shifting jobs. The second is that the UK believes it has some blackmail potential. A hard Brexit could cause financial instability in the eurozone, given its overreliance on London as a financial centre. And highly integrating supply chains in the car industry would be severely disrupted, which would have a negative impact on the whole of the EU.
We noted two Brexit-related comments that we thought are worth relaying. One is by Stephen Bush in the New Statesman who writes that it is unfair to criticise Theresa May for not being clear enough about what Brexit means. We know that the UK wants to leave the single market, introduce immigration controls, and get out of the jurisdiction of the ECJ. The problem is not that we don’t know what the UK wants, but that we don’t like it.
And Philip Collins makes an important observation in the Times. If the EU had responded to Brexit by proposing a two-tier structure with a more integrated eurozone and a less integrated EU, it could have forced a second referendum in the UK before Brexit. In that case it could have offered the UK the choice of accepting the new arrangements, which would have been similar to what David Cameron suggested during his Bloomberg speech - fiscal integration for the eurozone, but devolution for the non-eurozone in many areas including immigration policies, less focus on agriculture, and more on services liberalisation.
“Then suppose that all the benefits of this revised EU were offered to Britain just so long as we remained a member. Simultaneous with this process, Theresa May and Sir Tim Barrow will negotiate the best exit deal they can manage. Britain will prepare to leave the EU, as it was instructed to do on June 23. Then, when the two plans are ready they will be put, as rivals, to the British people in a referendum.”
It is not going to happen of course, since the EU is not responding in a forceful way to Brexit, just as it didn’t respond in a forceful way during the eurozone crisis when it established only the minimal reinsurance procedures to keep it going for another few years. The EU has become constitutionally incapable of responding to external threats.
Finally, in this context we noted an commentary by Ulrich Speck in FAZ, in which he argues that there is now a real possibility that Henry Kissinger's global trinity may become a reality - with spheres of influence dominated by the US, Russia, and China. He writes this would be a disaster for the EU, and for Germany in particular, which had relied so much on being integrated into the west’s economic and military architecture. He calls on the EU to act, but we are seeing the same pattern in security as we saw during the eurozone crisis: working papers and some symbolic decisions, like the joint HQs, but no real action.