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Although we think a deal can still be struck, we recognise that with less than 10 days to 31 December, we need to prepare for all eventualities.
The UK and EU have made significant progress on two of the most contentious issues: a level playing field in trade and governance. Fishing rights, however, are still the subject of intense negotiations.
From 1 January, goods entering the EU from the UK will have to undergo a number of new practices and controls, including customs declarations, rules on control of origin and food inspections.
For goods entering the UK from the EU, the UK government has decided to delay by six months the imposition of comprehensive controls. For financial services, there will no longer be equivalence.
Financial companies based in the UK and the European Economic Area will no longer benefit from passport rights. However, as the EU relies significantly on UK CCPs for derivative contracts, to avoid abrupt disruptions the European Commission has adopted an eighteen-month equivalence for UK CCPs.
For the time being, Prime Minister Boris Johnson, has ruled out an extension of the transition period to 2021. However, it is worth noting that since the Brexit referendum, none of the deadlines have been legally binding.
With real progress in recent weeks, and given that a no-deal would clearly not benefit anyone, both sides could once again agree to extend the negotiations.
One option would be for the European Parliament to approve an agreement in principle by 31 December and complete formal ratification in early 2021. In this case, short-term measures could be put in place to minimise any trade disruption before the new rules come into force.
Trade relations between the EU and the UK will return under the control of the World Trade Organisation. In addition to border controls, as the UK will cease to be part of the EU’s free trade area, most-favoured-nation tariffs and non-tariff barriers will apply to EU-UK bilateral trade. According to the WTO, the EU’s trade-weighted average tariff for non-agricultural products in 2019 was 2.6% and 9.2% for agricultural products.
But the tariffs applied vary widely between goods and cars from UK manufacturers would be taxed at 10%, while some dairy products could be taxed with duties of more than 35%.
The impact of a no-deal is difficult to assess. The models give a wide range of results, depending on their specifications (static trade models, dynamic stochastic general equilibrium models, gravity models) and the transmission channels considered (trade, tariff barriers, non-tariff barriers, uncertainty, confidence…).
Although the magnitude of the results varies considerably, all studies find that the UK will be much more affected than the EU: in the long run, the impact on GDP will vary from -3% to -9%, while the impact on the EU will be between -0.3% and -1.5%. This should come as no surprise given that the EU accounts for around 50% of UK trade, while the UK accounts for a much smaller share of EU trade.
A deal would prevent the UK’s trade relationship with the EU from reverting to WTO rules. However, it would not prevent cross-border controls on goods and the emergence of friction.
It is likely, however, to prevent a disruptive scenario in which trust would be severely undermined. While the relationship between the UK and the EU would continue to change on a lasting basis, an agreement would be good news for markets.
In the best-case scenario, if the vaccination campaign is successful and a trade deal is agreed, we expect UK GDP to grow by 6.8% in 2021. In the event of a no deal, sterling would likely remain in decline and the authorities would step in to provide further support.
However, GDP would barely grow at all, as no-deal disruption and higher tariffs would dampen activity. After a fall of 11.2% in 2020, UK GDP would remain 8% below the level recorded at the end of 2019!
Candriam’s main scenario on Brexit for now remains that of a last-minute deal. We are overweight UK equities and slightly overweight sterling.
UK equities should benefit from a Brexit deal and a recovery once we emerge from the health crisis. If there is a “hard” Brexit in early 2021, this is likely to increase the risk premium not only of assets in the UK, but across Europe, as well as weighing on currencies.
The virus remains the main problem in the short term, but in the long term, the political shape and attractiveness of Europe depends on finding a deal that does not disadvantage either side.
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