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May has work cut out for her in EU talks

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Today (4 December), over lunch with Jean Claude Juncker and Donald Tusk in Brussels, Theresa May and David Davis have to persuade the resident of the European Commission (EC) and the president of the European Council that "sufficient progress" has been made for the UK to begin trade talks with the EC that will shape UK-EU relations into Brexit and beyond. The timing of this meeting is particularly pertinent, since in just 10 days’ time the other 27 EU leaders will convene at the EC summit (14-15 December) to formally vote on whether trade talks can begin in earnest. Failure by the PM to convince the EU Council to agree to trade talks would likely lead to a delay until the next Council meeting in March 2018 – a full year after Article 50 was triggered and just one year before the UK officially leaves the EU. The EU’s chief negotiator, Michel Barnier, will compile a report to present to the EC on Wednesday, upon which leaders of each of the 27 countries will vote.
 
There are three main issues around which the PM must base her case for ‘sufficient progress. Firstly, the ‘divorce bill’ dispute revolves around the fact that the EU commits to spending on a five-year basis and the UK, therefore, has five years of funding commitments, though it won’t benefit from the funding after Brexit. It has been widely reported that the settlement here will be in the region of €50bn.
 
Secondly, Brexit will necessarily mark the end of treaties that guarantee the legal status of citizens’ rights in the UK and EU and vice versa. Clearly it is beneficial for both sides to resolve this; however, the court that should preside over disputes is the issue here. For many Brexiteers this gets to the crux of Brexit: in their view, the European Court of Justice (ECJ) cannot overrule the British supreme courts. The prime minister has promised that Brexit will end the jurisdiction of the ECJ in the UK. She has, however, suggested that its remit might continue during an "implementation period" after this date.
 
The third issue is the Irish border. Northern Ireland as part of the UK will leave the EU while the Republic of Ireland will remain, thereby creating a 310-mile border between the two trading blocs - the only land frontier. This is proving a particularly thorny issue to negotiate as the Good Friday Agreement will be 20 years old in April 2018. Arguably Northern Ireland has a potentially disproportionate amount to lose economically out of Brexit due to its heavy reliance on exports to the EU. Indeed, should the UK have to pay food and agricultural tariffs, the agricultural sector could be severely disadvantaged.
 
When May last presented Brussels with the British position on these issues in Florence in September she was rebuffed out of hand by her fellow EU leaders. This time around should be different, as the financial divorce settlement looks to be twice the size and other concessions have been made. Financial markets reacted with a considerable strengthening of GBP when details of the divorce settlement were leaked last week. Should further agreements pave the way to the next stage of negotiations on trade, with ratification at this month’s EC meeting, expect similar, positive sentiment towards the pound. However, getting to this stage, starting with May’s meetings today, still requires clarity on the regulatory framework in Northern Ireland and, critically, the ECJ’s role, if any, within the British judicial system.
 
The Northern Irish issue is made more complicated by the deal May made with the DUP after the last general election. The DUP, on which May’s government is reliant for a parliamentary majority, has made its position abundantly clear to the PM and the DUP will use its position of strength here to ensure that nothing similar to staying in the customs union or single market is agreed. Nigel Dodds, DUP leader in parliament, has stated that any solution involving an all-Ireland customs union will push the North further from its main trading market – the UK – and as such will not be acceptable. Simon Coveney, the Irish foreign minister and deputy PM, was as firm as his Northern Irish counterpart, stating “...we cannot allow some kind of unintended consequences of Brexit to have the recreation of a border”.
 
It will be interesting to see how markets react if May asks for more time to broker this politically charged hurdle with further talks before the EC meeting.
 
An interesting week is in promise elsewhere and on the data front. The UK construction PMI came in this morning at 53.1 against a forecast of 51.0. This followed an exceptionally strong manufacturing PMI last Friday of 58.2, beating expectations of 56.5. Attention will now shift to the crucial services component on Tuesday, where a figure of 55 is expected for November, after October’s 55.6. Tuesday also sees the RBA rates statement alongside PMI numbers or the eurozone, where a composite figure of 57.5 is expected. Wednesday sees GDP out of Australia and the Bank of Canada rates statement where the Bank is expected to maintain its ‘wait and see’ policy stance in order to assess the effects of the summer rate hikes. On Thursday weekly jobs figures for the US are released, Draghi also speaks at the General Council meeting of the ECB in Frankfurt, and then on Friday it is the closely watched non-farm payrolls out of the US - consensus is for a 200,000 rise. Despite the raft of data earlier in the week, as usual, it will be the non-farms that have most potential to create movement in both interest rate and FX markets.

 

All views expressed here are the Author’s own and are based on information available at the time of writing

 

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