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October 19, 2018

More optimism about a Brexit deal in Brussels. Less in London

There is a duality in the Brexit process - a trade-off between the likelihood of a deal against the likelihood of ratification. This week, the former went up, and the latter went down. We have been close watchers of more than a few conflicts in the EU over the last 30 years, but none quite so intractable as this one.

The chances of a deal in the European Council are indeed higher. What we find particularly significant was the intervention by Angela Merkel who urged both sides to show compromise. As the FT reported this morning some observers saw in her remarks a message that the EU negotiating team should rethink its approach to the Irish border. She also stressed that in the event of a no-deal Brexit there would be a hard border in Ireland, something the Irish government still seems to be in denial about. Her intervention seems to have puzzled some of those present. We are far less puzzled. If you know about Germany’s massive dependence on trade with the UK, the last thing Germany needs right now is a hard Brexit. Germany supported a united EU front against the UK. One of the Brexit predictions we made was that Germany would soften its line as talks headed into the final phase. This seems to be happening now.

There is now one, and only one, avenue towards successful Brexit deal: a late agreement, possibly as late as early January. As became evident this week, this agreement will involve a longer transitional period, but it will also include new elements with the aim to provide a political safeguard to the UK that the Irish backstop need not be triggered. It will also be essential for the EU to accompany the deal with a formal commitment that it will not renegotiate the withdrawal agreement with another UK government, should one emerge, and most importantly that it would not extend the exit timetable. It is only if a Commons vote can be credibly framed as a take-it-or-leave-it decision, that a withdrawal agreement has a chance of being ratified. That is not the case at the moment since everybody pretends that they can negotiate a better deal.

The reaction among UK Brexiteers to a longer transition period is bordering on the hysterical. The ultras are now openly campaigning for a no-deal Brexit. They are urging May to reject any notion of an Irish backstop - which amounts to the same. The DUP's language was more moderate. They said that an extension of the transition does not solve the problem, which is of course correct. We would add that it could be part of a wider package that does.

We thought the most informative story we read yesterday came from Stephen Bush of the New Statesman, who looked at the circumstances in which pro-European Labour MPs could support a deal. He said they openly admit that they are fearful of rejecting May’s deal because that might trigger a no-deal Brexit. The Tory pro-Europeans argue - rightly in our view - that May’s version of a Brexit is the only one that could find acceptance by a cross-party majority in the House of Commons. We noted yesterday that the Irish government was supporting the idea of a backstop that included all of the UK. In other words, a backstop that could leave the UK in the customs union for as long as it takes to agree a free-trade deal. May has already rejected that - at least in this crude version. 

She does not insist on an exit date, but hopes to negotiate provisions creating a semblance of finality to the process. Bush makes the point that May faces the choice of a customs-union Brexit that will critically depend for ratification on a Labour rebellion, especially from Labour MPs from leave-voting constituencies. They oppose a soft Brexit, but they also have a lot to lose from a no-deal Brexit. Bush concludes that this faction may be too small to save her Brexit deal.

A final thought from us: As we are now headed into overtime, preparation for a no-deal Brexit are starting in earnest on both sides. This will continue even after a deal, all the way until ratification in the House of Commons which may not happen before March. If there is no majority for May’s position early on after a deal, preparation for a no-deal Brexit will intensify dramatically, in the industry, in the UK government, in the other EU27 member states and at EU level. We would expect the EU and the UK to negotiate a series of mini-agreements to ensure that customs borders are technically operational. We think a no-deal Brexit is undesirable for many reasons, but we should not overestimate the potential of a no-deal Brexit to scare hesitant MPs at a time when most of the frictional costs associated with a no-deal Brexit, will have already been incurred. We fear that another Project Fear episode, this time in relation to a deal, could badly misfire. We think the best strategy for May is to go for a 9-12-month extension of the transition period and a barebones trade deal - one that only requires EU-level agreement - as a backstop to underline the finiteness of the transition.

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