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Article 50 notification ruffles few feathers

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A week that was dominated by probably one of the most, if not the most, significant event of our lifetimes, the UK’s withdrawal from the EU through the Article 50 notification letter, was greeted with almost eerie calm in the debt markets. Whether they will be able to maintain such calmness through the next two or more years of negotiations would seem unlikely.
The opening salvo of letter writing has been relatively cordial, with Theresa May heading off one area of disagreement by admitting that the UK would honour its financial obligations, or ‘exit bill’ as it is commonly known. Whether she hoped that this would persuade the EU to negotiate this amount and a free trade deal at the same time is not known, but if it was the intended effect it appears to have failed. Some commentators noted that the EU letter contained a comment that some issues might be addressed as soon as “sufficient progress” had been made. Given recent comments from both Chancellor Merkel and President Hollande, we doubt that this included trade negotiations. Unfortunately, as readers of this bulletin will be aware, we have warned that agreeing the exit bill is the EU’s main priority and it is unlikely that any other issues will be addressed prior to the resolution of the exit bill. 
However, there was no doubt that May was doing her best to keep her EU counterparts as friendly as possible. While not referenced directly, the continued influence of the European Court of Justice was tacitly admitted when she noted that UK companies would have to align with rules agreed by “institutions of which we are no longer part”. The ECJ will have control over the standards of 47% of the UK’s exports.
The main focus of attention is now turning to immigration, and with this will come the realisation of the horrendous damage that the Brexiteers have caused by stirring up this issue. The media, so far, have concentrated on the impact that the UK’s removal from the EU will have on those Brits who have been whiling away their later years in Spain and other popular sunny climes. There also appears to be a surprisingly large number of EU citizens living in the UK. Arriving at a mutually beneficial pact to cover these citizens should be relatively easy. The problem arises from the fact that the UK’s EU workforce is many times larger than the number of UK workers employed in the EU. Some UK industries such as construction, hospitality and agriculture are almost entirely dependent on EU migrants, while other professions such as healthcare and advanced technology are desperate to continue to recruit EU nationals in order to fill the chronic shortage of qualified staff those sectors are experiencing.
The portents are not good. A survey by the Resolution Foundation found a decrease of 50,000 in the UK’s EU workforce in the final quarter of last year. It would appear that the lower skilled were largely absent from this decrease, with the report stating that the leavers were largely “bankers, builders and nurses”. Rather ironically, it seems that the decline in the value of the pound is as much a reason for leaving as the lack of political will being demonstrated by the current Government. Since the high level of immigration over the past few years has been such a problem to the Government, it will no doubt be pleased to see the decline in the EU workforce and hope that it accelerates. The problem is that of who is going to do the vacant jobs left behind. Unemployment is at cyclical lows, and if one takes the major increase in non-productive civil servants that will be required to manage all the new government entities, a large fall in the EU workforce will have an inevitable negative effect on GDP and the deficit. Interestingly, David Davies appears to have had a mini conversion and has started to propose a flexible workforce solution depending on economic needs. He will be lucky to agree the terms of that within two years.
While May has some oddly unhelpful views - she may be about the only UK politician who regards overseas students as migrants - she has a difficult balancing act to perform in protecting the UK’s economy while at the same time keeping her right-wing, little Englander faction under some sort of control. It will not be an easy task, with the debate over the size of the divorce bill giving an early indication of just how far apart the two sides are.
This week should inform us on whether the UK is managing to maintain its momentum. The CIPS manufacturing index was released this morning and showed a decline to 54.2 against a median expectation of a rise to 55.0. Hardly anything to get concerned about, although Markit, who produce the survey, project further weakening. The more important CIPS survey of the service sector is released on Wednesday and is expected to show very little change from last month’s 53.3 reading.
Friday sees the release of the latest trade, industrial production and manufacturing output figures. The trade figures seldom have an impact on the market, but may on this occasion. The decline in the value of the pound has had a beneficial effect on the trade deficit, which dropped to £2bn last month. There is quite a wide divergence in views on its continued direction. The median forecast is for a relapse to a deficit of £2.2bn, but there are several forecasters going for a better result, with Capital Economics leading the way with a reduction to £1.6bn. Industrial production is expected to return to growth, albeit at only 0.2%. However, we return to a divergence of views when it comes to manufacturing output, with the median forecast being for a 0.4% decline - but with others notably more optimistic.
Even so, it is going to take a fairly remarkable domestic economic statistic to move prevailing interest rate levels to any notable degree while the markets remain Brexit-focused – a situation which is unlikely to change for some time to come.
All views expressed here are the author’s own and are based on information and data available at the time of writing.




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