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What have we been up to


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What kind of year has it been?

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Screenwriter Aaron Sorkin, writer of The West Wing, is fond of naming his series finales ‘What kind of a day has it been?’, recalling a question that the producer of his first play would ask him at the end of each evening’s rehearsal. With global politics seemingly unable to escape the melodrama into which it descended some time ago, it seems a reasonable question for us to contemplate as 2017 draws to a close.
If this was supposed to be the year in which the world faced up to the consequences of the previous one’s geopolitical shocks, it failed to live up to its designated narrative. Precious few of the headline issues from 12 months ago have been resolved, and we have ended the year with more questions asked than answered.
In light of recent events, Brexit seems an obvious, if tedious, point of focus. The last couple of weeks saw the UK secure the European Council’s agreement to proceed to Phase Two of withdrawal talks, which aim to determine the nature of the UK’s future relationship with the bloc. This agreement did not come without a price, of course, namely concession to all key demands made by the EU during the first phase of negotiations. The UK will honour its EU funding obligations for the next five years, resulting in a net payment of some €50 billion spread over that period. Meanwhile, legal questions around the rights of EU citizens in the UK will continue to be referred to the European Court of Justice (ECJ) for the next eight years, and UK courts will have to pay “due regard” to its decisions indefinitely. There will be no hard border in Ireland, with the UK government having agreed to keep Northern Ireland in ”full regulatory alignment” with the Republic of Ireland.
That final concession proved a sticking point in negotiations, with Theresa May facing a last-minute rebellion from the DUP over the prospect that, in keeping Northern Ireland’s regulations in line with those of the EU, they would move further away from those of the rest of the UK. A solution was found in the guarantee that Northern Ireland would at the same time remain in full regulatory alignment with the rest of the UK. One is reminded of the Zeroth Law of Thermodynamics (so named because it was thought too obvious to merit being numbered by a positive integer), which asserts that if System B is in equilibrium with System A, and if System C is similarly in equilibrium with System A, Systems B and C must also be in equilibrium. In other words, if Northern Ireland is simultaneously to remain in regulatory alignment with the EU and with the rest of the UK, the UK must remain in regulatory alignment with the EU. The prime minister’s sop to the DUP would therefore seem to amount to nothing less than an agreement that the UK will continue to abide by the regulatory requirements of the single market even if it is not able to enjoy the benefits of being a member.
To those who started the year arguing that the UK’s withdrawal negotiations were likely to be somewhat more difficult than David Davis seemed to think, the nature of these concessions may not be a tremendous surprise. Much more mysterious is the relative lack of protest emanating from the Conservative Party’s Eurosceptic wing. It is understandable that the eventual size of the divorce bill did not give rise to too many objections: it will no doubt cause political difficulties in the future but, on the scale of both national budgeting and the UK’s annual exports to the EU, is not actually a great deal of money. It is much harder to see why the indefinite jurisdiction of the ECJ has been accepted with so little complaint given the importance that the Leave campaign placed on the sovereignty of the UK parliament and courts. One cannot escape the feeling that certain backbenchers (not to mention certain cabinet members) are simply biding their time in order to see what further concessions Phase Two brings. Who knows – they may end up feeling quite grateful to the 11 Conservative “mutineers” whose votes have given them the right to reject whatever agreement Davis eventually secures at the last minute in favour of a ‘no deal’ withdrawal.
If all this paints a rather disparaging picture of the UK’s prospects, it is important to remember that the group from which we are withdrawing is a very long way from being a model of unity. It is fair to say that the plethora of elections we have seen in continental Europe did not exactly continue the nationalist trajectory that swept President Trump into office and the UK out of the EU, but neither did they stop it in its tracks. On the one hand, it is true that the French and Dutch electorates roundly rejected the nationalist candidates they were faced with, while in Italy Matteo Renzi’s referendum defeat in late 2016 failed to propel the anti-EU Five Star movement into power. Yet in Austria, last Saturday saw Heinz-Christian Strache’s far-right Freedom Party enter government in coalition with the centre-right People’s Party. Strache’s more Eurosceptic sentiments will apparently not form part of the coalition’s legislative agenda, but his links to Vladimir Putin’s United Russia party will surely make it more difficult for the EU to continue its program of sanctions against the Russian government.
Most troublingly of all, we are faced with a Germany that still lacks a government after the pro-business FDP chose to walk away from coalition talks with Angela Merkel’s Christian Democrats. At the time of writing, this does not seem to make it any more likely that the far-right Alternative für Deutschland will get anywhere near the levers of power, although their astonishing 12.6% share of the vote should still give moderates significant cause for sober reflection. Chancellor Merkel has turned to her old coalition partners (and key opposition party), the Social Democrats, who despite having at least twice ruled out the prospect of going back into coalition with the CDU have now indicated that they are willing to conduct ‘open-ended’ talks. The snag is SDP leader Martin Schulz’s key condition for such a coalition: that Germany should push for a United States of Europe by 2025, with any country unwilling to sign up to such a union being forced to leave the EU. I am sure that there are more effective ways to whip up violent nationalistic sentiments, encourage the rise of the far-right, and hasten the fracturing of the EU – but none spring immediately to mind.
The point is that neither the UK nor the EU can guarantee that the priorities of their negotiating teams one year from now will be remotely similar to what they are today. Simply put, too many of the countries involved are too close to political implosion. Combine this with the ‘nothing is agreed until everything is agreed’ mantra that both sides are so keen to repeat, and it is hard to avoid the conclusion that the ‘progress’ that has been made thus far could well be a mirage. Small wonder then that most financial markets have spent much of the year eschewing the large swings in sentiment we saw in 2016 in favour of a cautious, reluctant creep.
History would suggest that this situation cannot persist indefinitely. In one year’s time, it is conceivable that we will still have frustratingly little clarity over the UK’s future position in the world, but by then most businesses will have had no choice but to make their assumptions and put them into action. They will be doing this against a backdrop of considerable uncertainty: a US whose recovery is worryingly long in the tooth, but which may finally be chipping away at taxes and regulations; a Chinese economy that has dropped out of the news cycle in recent months but which looks scarcely less bubbly than it did two years ago; and a world in which global debt is now more than three times greater than economic output. 2017 felt like a year in which market participants were holding their breath and waiting to see what would happen next. 2018 may well be the year in which they find out.
Upcoming Economic Releases
As would be expected, the week running up to Christmas is set to be a slow one for data. On Thursday we will see the UK public sector net borrowing figure (expected at £8.5 billion, up from £7.5 billion last month), followed by the final adjustments to third quarter GDP growth on Friday. No changes are expected in the latter release – although by this point liquidity is likely to be so low that even a slight surprise could lead to a material market shock.
Finally, we would like to take the opportunity to wish all our readers a very merry Christmas, and a happy, healthy, and prosperous year to come.




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