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Wanted: Broken logjam

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One could have been forgiven for thinking, on Friday afternoon, that it had all gone rather well. Theresa May’s Florence speech had been billed as the event that would finally “break the Brexit logjam” and, at first blush, she made a decent go of it. While the policy content of the speech differed on only a few points from that in last year’s address at Lancaster House, her emollient tone marked a significant – and extremely welcome – development.
 
In sharp contrast to previous insulting comments about “citizens of nowhere”, the prime minister took great pains to emphasise that the UK would remain a hospitable country for those EU nationals who choose to live here. The words “we want you to stay; we value you; and we thank you for your contribution to our national life” were a relief to hear – which says a great deal about the degree to which public rhetoric around immigration has degenerated of late. More concretely, May conceded that decisions made by the European Court of Justice with regard to the rights of EU citizens would be taken into account by UK courts, a move that was welcomed as ‘constructive’ by EU chief negotiator Michel Barnier.
 
On security cooperation, the statement that “the United Kingdom is unconditionally committed to maintaining Europe’s security” also triggered sighs of relief on both sides. Many had previously interpreted elements of the Lancaster House speech as a thinly veiled threat that the UK would reduce its level of support for the security services of its neighbours. Understandably, this caused some alarm: quite aside from the bad faith such a step would have introduced to negotiations, it would also have caused significant harm to the safety of UK citizens. In a world where the most severe security threats come from organisations wishing to overturn western civilisation as a whole, cooperation with one’s neighbours – whether geographical or ideological – is not an optional extra.
 
Most important with regard to future negotiations, though, was the formal acknowledgement that after the UK’s departure in March 2019 there should be a transition period to provide both sides with the time to adjust to the new relationship. The prime minister’s proposal that this should last for two years, during which time the UK would continue to abide by EU regulations and pay into its budget in exchange for continued access to its markets on current terms, left business leaders markedly more reassured that the country would not simply fall off a cliff-edge. Moreover, it represented a first tentative step by the UK government towards an explicit figure for the ‘divorce bill’: the fulfilment of financial obligations for two years will involve a net payment of approximately €20 billion by the UK. While this is well short of €60 billion (the net value of the €100 billion currently demanded by EU negotiators, after stripping out payments from the EU to the UK), it does not include longer-term commitments, which will remain a topic of debate. Given the time it has taken to get to this point, however, it must be regarded as progress – as indeed it has been by the EU negotiating team.
 
Under the circumstances, therefore, the fact that rating agency Moody’s chose Friday night to announce its downgrade of the UK’s credit rating to Aa2, citing the challenges of Brexit together with their assessment that public finances were more stressed than the Treasury believed, was both surprising and disheartening. What made it more so was that it also came at the end of a week in which the UK’s public finance deficit fell to its lowest level since 2007, meaning that the chancellor of the exchequer, Philip Hammond, will have an additional £10 billion to spend in the upcoming Autumn Budget. Admittedly, this falls short of the promised post-Brexit boon of £350 million a week (a figure that foreign secretary Boris Johnson somewhat bizarrely chose to repeat last week) but it does have the advantage of being actual money rather than a wilful fabrication.
 
While the downgrade itself was unpleasant news for the Treasury, the chancellor will have been reassured by the fact that the markets do not seem to have taken it to heart. Ten-year gilt yields actually fell following the announcement, and sterling barely moved at all – particularly in the context of the significant gains made over the past week in response to the Bank of England’s hawkish turn. Whatever the political considerations, market participants do not seriously think that the UK will be defaulting on its debt any time soon.
 
Brexit, of course, was far from the only issue on the table in what was an eventful week worldwide. Tension continued to rise over North Korea, with President Donald Trump using his first address to the UN General Assembly to threaten to “totally destroy” the country if America is forced to defend itself or its allies. As with several recent announcements by the US commander-in-chief, though, markets failed to show much of a reaction, presumably by now suffering from Armageddon-fatigue.
 
More significantly for the US economy, Federal Reserve chair Janet Yellen used the press conference following the FOMC’s most recent meeting to reiterate her commitment to reducing the institution’s $4.5 trillion balance sheet and to bringing an end to quantitative easing. Despite the continued (and somewhat mysterious) lack of inflation, Yellen’s comments were hardly a surprise – she has been carefully telegraphing her intentions since early 2017. Nevertheless, her appetite to proceed with her tightening program buoyed Treasury yields across the maturity spectrum. Whether she will be able to see her plan through, however, with her first term as chair ending in February 2018 and the White House now eyeing up four vacancies on the Fed’s Board of Governors, is another question.
 
Upcoming Economic Releases
The coming week is set to be a quiet one for data, with the main event being the release of inflation data for Germany and France on Thursday and Friday respectively. Minor upward changes to consumer price increases are expected, although given the extent to which the euro has rallied so far this year, any undershooting of these expectations has the potential to lead to a sell-off. The end of the week will also see revised readings for US and UK GDP growth, where again no significant alterations are expected

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