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By all accounts the starting gun on Brexit could be fired this week, with commentators suggesting that Theresa May could trigger Article 50 as early as Tuesday – assuming, as is expected, she is able to overturn the Lords amendments today. Whatever the specific timing, the EU will waste no time in responding with clarity on its negotiating position with Donald Tusk, the re-elected EU Council president, suggesting that the EU will issue its guidelines for negotiation within 48 hours of notification.
Top of the EU’s agenda will be a divorce payment. With some commentators mooting figures as high as £60bn, expect a heated start to negotiations. Government sources have been leaking legal advice they have received implying that the UK has no legal responsibility to pay any such bill. However, Michel Barnier, who will lead negotiations on behalf of the commission, has suggested that the divorce payment and other divorce terms must be agreed before discussions on a post-Brexit settlement can begin. With only two years to do a deal there is no time to be wasted, and a compromise will be needed soon. Prime Minister May ought to expect more challenging adversaries on the continent than those she has swept aside domestically.
With such a small parliamentary majority, issues like the divorce payment could prove challenging for her at home. By all accounts, the lack of credible domestic opposition has some in government nervous about the potential for dissent within the Conservative Party’s ranks. Evidence of the fragility of her majority could be seen this week following Hammond’s spring budget, in which he risked the wrath of back-benchers with tax increases, some of which fly in the face of their manifesto. As a result, some within the government have suggested calling a snap election to secure a larger majority and mandate for her negotiating stance on Brexit. While such a move seems unlikely, the government will certainly have to be cleverer about using its remaining political capital.
The spring budget followed recent policy disappointments, including the housing white paper and the new industrial strategy; however, with the economic uncertainty surrounding Brexit at the forefront of the Chancellor’s mind, it was probably prudent to keep the rabbits in the hat. Still, with the OBR increasing GDP growth forecasts for 2017 to 2% from 1.4% in November, there certainly must have been a temptation. The new forecasts allowed government borrowing projections for the year to be revised down by £16bn. Meanwhile, the OBR raised an overall cautionary note, stating that the recent relative strength of the UK economy was built on household borrowing and that the potential for sustained growth was therefore limited. Furthermore, and seemingly not lost on Hammond, the OBR has not changed its prediction on the impact of Brexit, instead simply pushing it out.
In the US, Wednesday should see the Fed undertaking a quarter-point rate increase, its third increase since December 2015. The growing certainty of such a move by the Fed comes off the back of impressive non-farm payroll figures in February of 235,000 (these had been projected closer to 200,000) bringing the US unemployment rate to 4.7%. This means that the employment-to-population ratio reached 60% for the first time since 2009. The Fed has also been heartened by wage growth which increased from 2.6% to 2.8%, having been 2.3% a year ago. This marks a remarkable shift in expectations, with the market having only three weeks ago deemed a March rate hike extremely unlikely, and has resulted in the 10-year treasury yield increasing from 2.30% to 2.60%. As a result, the odds on four rate increases in 2017 have doubled to 25%.
In Europe this week Draghi proudly proclaimed victory over the deflationary forces which have dictated monetary policy for the last seven years, thereby signalling a gradual shift in policy. It appears that continuing improvements in employment conditions and growing growth expectations are of growing influence in the ECB’s forward guidance. While whispers of tightening monetary policy are likely to be premature, the probability of a rate increase in December 2017 now stands at 50%, having been 10% at the beginning of the week. As a result, the five-year swap rate increased to 0.20%, up from -0.05% at the beginning of the month. One certainty is that the ECB is highly unlikely to increase rates without firm evidence of a sustained rise in inflation and wage growth, especially considering its last rate increase in 2011 was seen as choking off the recovery.
Political events are likely to be of most interest this week, with Merkel in Washington on Tuesday and the general election in the Netherlands on Wednesday. The markets will also be looking to the G20 finance ministers’ meeting this week, where a protectionist tone is expected.
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