The A-Team had a plan, the British government has a nebulous goal

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The UK has its own eclectic A-Team led by Prime Minister May, tasked with getting the UK out of the EU and securing a more beneficial relationship with trading partners.

Theresa May, David Davis, Liam Fox and Boris Johnson have been dealt a tough hand and unsurprisingly have so far refused to reveal the intricate details of their daring plan.

But voters, businesses, parliament, EU leaders and foreign trading partners are pressing the government to elaborate on its tactics and strategies for Brexit.

There was break-through of sorts on 7th December, with the 650 members of the House of Commons (MPs) voting overwhelmingly to allow the government to trigger Article 50 by end-March in exchange for publishing the details of its Brexit plan.

But the devil is in the detail – or lack thereof. This parliamentary vote is not binding and the government has only agreed in the vaguest of terms to publish its plan for Brexit.

If MPs receive the plan late in the game and/or it is insufficiently detailed and assuming the Supreme Court rules that government has no prerogative to trigger Article 50, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

Moreover, this likely vote in the House of Commons and House of Lords may well be only one of multiple votes which parliament has to hold between now and the approval of a final treaty between the UK and the EU.

In addition to these possible parliamentary hurdles, the government may also have to navigate a number of pending legal cases.

Some of these parliamentary votes may not take place and these legal actions may fail. There is certainly scope for further compromise between Theresa May’s government and parliament.

But the risk is that this reputation-sapping cat-and-mouse game extends beyond March, in turn making it far more difficult to predict the end-outcome – which ranges from the UK reverting to WTO rules (the “hardest” form of Brexit) to the UK staying in the EU.

Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at an unidentifiable point in the future, forecasting Sterling remains fraught with difficulty.

In this context I would expect Sterling to continue lacking direction near-term, particularly as the FX market has, it would seem, already priced out the more negative scenarios for the UK economy. Mixed UK data may not provide Sterling with much direction either way.

Like the A Team’s protagonists, May, Davis, Johnson and Fox have “a plan”

In the 1980s TV hit-series The A-Team, the good and the oppressed would hire four soldiers of fortune led by Colonel John “Hannibal” Smith, to deal with a problem that no-one else was willing or able to solve. Hannibal was the brains and master of disguises, B.A. Baracus the brawn and team mechanic, “Howling Mad” Murdock the eccentric but brilliant pilot and Templeton “Faceman” Peck the smooth-talking master of the persuasive arts and team accountant.

Invariably the A-Team would get into hot water but Hannibal would conjure up a daring and unorthodox but effective plan to get his team out of trouble. This plan – initially hidden in part from TV viewers – usually involved the four protagonists cobbling together from almost nothing a brilliant contraption. The A-Team would go on to save the day before once again vanishing in the sunset, with Hannibal uttering the immortal lines “I love it when a plan comes together”.

The UK has its own A-Team, made up of Prime Minister Theresa May, the Brexit mastermind, and her three euro sceptic cabinet members – the hard-talking Secretary of State for Exiting the European Union David Davis, the eccentric but popular Foreign Minister Boris Johnson and finally Secretary of State for International Trade Liam Fox, the “details-man”.

This eclectic team has, on paper at least, been tasked with a simple goal: to respect the will of the British people, get the UK out of the European Union and secure a bespoke and more beneficial relationship with the EU and other trading partners. May has stated her aim of triggering Article 50 of the Lisbon Treaty by 31st March 2017, which would see the UK exit the EU by March 2019, and outlined her wishes for the UK including access to EU markets, control over immigration and a reduction or cessation of payments into the EU budget.

 

Government asked to conjure up daring escape from EU out of thin air

But like Hannibal, B.A. Baracus, Face and Murdock, May, Davis, Fox and Johnson have been dealt a tough hand. For starters, they have been in their current roles for less than five months. They have limited time as British voters, businesses, EU states and foreign leaders are pressing them to get on with it. They have limited resources to undertake probably the most complex legal, constitutional, political, economic, financial and social project that any EU country has ever had to contemplate. They have no ready-made blue-print on how, when and by whom negotiations to leave the EU should be conducted – the assumption was seemingly that the “remain” vote would win. Finally, they have no precedent to rely on as no EU member state has ever left the EU.

It is therefore perhaps unsurprising, that in the same way TV viewers were left guessing about the details of Hannibal’s plan, Theresa May has so far refused to reveal the intricate details of her daring plan, including  the terms and conditions of the UK’s exit from the EU and of the UK’s new deal with the EU. Her argument is that she does not want to reveal her strong negotiating hand to the other 27 EU leaders – or could it simply be that she does not have a detailed proposal to reveal. TV viewers trusted Hannibal’s clever plans and Theresa May is effectively asking the British electorate (and the rest of the world) to do the same.

 

Increasing pressure on government to reveal details of its Brexit plan

But that is where the comparison with the A-Team probably ends. Whereas Hannibal’s plans, however far-fetched, were rarely queried, Theresa May’s A-team is under growing pressure to elaborate on its tactics and strategies. Senior EU policy-makers are adamant that the British government’s current wish-list is simply unrealistic and are asking for a re-think. At the same time, British households, UK-based businesses and foreign trading partners are pushing for greater clarity and reassurances they will not be negatively affected. Importantly, members of the lower house of parliament (House of Commons) have been sceptical of Theresa May’s cunning plot and demanded to have a say on the matter.

There was break-through of sorts on 7th December, with the 650 members of the House of Commons (MPs) voting overwhelmingly in favour of the government triggering Article 50 by end-March in exchange for publishing the details of its Brexit plan (461 MPs voted in favour, 89 against). Both sides have claimed victory.

The government is arguing that MPs will have to respect the timeline it has set, even if the Supreme Court, expected to announce a decision in January, upholds the High Court’s ruling that both houses of parliament have to vote in favour of granting the government the right to trigger Article 50. The government’s thinking is that is has effectively bought an insurance policy should the High Court’s November ruling be upheld (which is currently the consensus view). MPs believe that last week’s vote affords them important oversight over the content of the government’s Brexit arrangements.

But the devil is in the detail – or more specifically in the lack of detail. For starters, last week’s parliamentary vote is not binding. In theory MPs would be expected to honour the result of the vote and Article 50 triggered in the next three and half months. However, in practise, they have no legal or constitutional obligation to do so if they believe that the government is not upholding its end of the bargain.

 

Agreement between government and MPs is short on specifics and potentially problematic

And herein lies the second problem – the government has only agreed in the vaguest of terms to publish its plan for Brexit. It has not specified when it would share it with MPs, what level of detail it will provide or whether MPs will have the right to query and potentially amend the plan.

Theresa May will likely want to give away as little information as possible – her underlying position since she became prime minister in July – in the hope of minimizing the risk of MPs querying the more controversial details and potentially seeking amendments. The government may also opt to delay publication of its plan in the hope of forcing it through without any major amendments.

But if MPs receive the plan late in the game and/or it is insufficiently detailed, they could plausibly delay a vote granting government the right trigger Article 50 by end-March 2017. They would have this power if a majority of the eleven Supreme Court judges, which heard arguments from both sides on 5-8 December, upholds the High Court’s ruling that the government has no prerogative to trigger Article 50.

MPs have not specified when they expect to see the government’s plan nor its format, but realistically they would want a detailed white-paper and at least a couple of months to digest its content. Moreover, if MPs feel strongly enough that the government’s proposal is not credible and/or damaging to the UK they could push for amendments, which could in turn delay the triggering of Article 50 beyond March – a risk I had already flagged  in Post referendum circular reference (7 July 2016).

In a more extreme scenario, if MPs are pushed to vote blind or to vote for an almost irreversible process which they view as damaging to the UK, they could opt to vote against giving the government the right to trigger Article 50[1]. Effectively voting against the referendum result would be a significant break with precedent[2]. But most parliamentarians’ political survival is arguably conditional on safeguarding the British electorate’s economic interests, not just respecting the wish of the 52% which voted in favour of Brexit.

 

Multiplicity of potential parliamentary votes and legal challenges

Moreover, this likely House of Commons and House of Lords vote on whether to grant the government the right to trigger Article 50 (call it vote Number 1) may well be only one of multiple votes which parliament has to hold between now and the approval of a final treaty between the UK and the EU.

  • Assuming that a majority of members in both the House of Commons and House of Lords vote in favour of allowing the government to trigger Article 50, they will then likely have to vote to rescind the 1972 European Communities Act (the Great Repeal Bill). Members of parliament would effectively be voting on which EU laws to repeal, amend or retain (call this vote Number 2).
  • Some members of parliament and a number of senior cabinet members, including Chancellor Philipp Hammond, are also pushing for the UK to cement a transitional deal before it formally ceases to be an EU member in 2019. They argue that, realistically, a final deal will not be ready within the two-year timeframe specified in Clause 3 of Article 50 (and this two-year window may actually be closer to 18 months as the European Parliament and European Council would need time to vote on the terms and conditions of the UK’s exit from the EU). David Davis has so far played down the need for such a transitional arrangement but if it does see the light of the day, MPs may want a vote on whether to approve it (call this vote Number 3).

In addition to these possible parliamentary hurdles, the government may also have to navigate a number of pending legal cases.

  • Claimants are planning to launch a new legal process in the British High Court arguing that the UK’s departure from the EU would not automatically trigger exit from the European Economic Area (EEA) and Single Market as the government claims. Specifically, Peter Wilding – Chair of pressure group British Influence – and lobbyist Adrian Yalland contend that parliament would have to trigger Article 127 of the EEA (with at least 12 months notice) in order for the UK to leave the EEA and Single Market (call this Vote number 4).
  • Separately, a British lawyer is planning to file a legal challenge with the Irish High Court, on similar grounds, against the Irish government, European Council and European Commission. Mr Jolyon Maugham QC is also seeking clarification on whether it is possible for the UK to single-handedly revoke a decision to trigger Article 50 at a later date (rather than requiring a unanimous decision by the 28 EU member states). Finally he is querying whether the UK government actually triggered Article 50 back in October and whether, as a result, the EU Commission has been in breach of treaty duties by refusing to commence negotiations with the UK. Mr Maugham is seeking for his case to be referred to the European Court of Justice in Luxembourg.

 

Room for compromise but clear risk of Parliamentary trench warfare

Of course, some of these parliamentary votes may be combined or not take place at all and these legal actions may fail. Indeed, there is scope for further compromise between Theresa May’s government and parliament.

Prime Minister May has already shown her willingness to compromise in order to achieve her twin objectives of getting the UK out of the EU within a reasonable timeframe and keeping the majority of her Conservative MPs on side, in line with my expectations (see The lady is not for turning (yet), 14 October 2016). She would arguably lose credibility if the timeline she set in early October slips, not to mention if MPs took the unprecedented, albeit unlikely, step of effectively blocking the triggering of Article 50. At the same time MPs will be weary of stalling, let alone killing a process which a (slim) majority of the British electorate voted for and of potentially forcing early general elections.

But the risk is that this reputation-sapping cat-and-mouse game which the government and factions of MPs have played since 23rd June extends beyond March 2017 and that parliamentary trench warfare, which weakened John Major’s premiership in 1992-1993, comes to characterize Theresa May’s tenure. This uncertain path in turn makes it far more difficult to predict the end-outcome, which ranges from the UK reverting to World Trading Organisation (WTO) rules (arguably the “hardest” form of Brexit) to the UK staying in the EU.

It is worth noting that EU policy-makers have theoretically limited influence on the timeline which the UK adopts. The European Parliament and European Council only vote on whether to approve the terms and conditions of a member state’s exit from the EU after that member has officially triggered Article 50. But further delays to the British government’s timetable would likely harden EU policy-makers’ negotiation stance, in my view.

 

Near impossible to paint clear outlook for British economy and Sterling

Ultimately, constant shifts in momentum between the government and MPs, the multiplicity of possible legal, political and ultimately economic outcomes and potential elasticity of the Brexit timeline make it near impossible to paint a clear outlook for the British economy and currency. Put differently, forecasting Sterling is fraught with difficulty given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at an unidentifiable point in the future.

Even if one was able to accurately predict the nature and timing of the UK’s final or even transitional deal with the EU, it would still be challenging to forecast Sterling. The US presidential election is a case in point. Even if markets had been able to accurately predict the surprising election outcome, they may still have been caught out by a US dollar and equity rally which confounded expectations that a Donald Trump victory would hurt US asset prices.

In this context I would venture that Sterling may continue to lack direction in the short run (see Figure 1). The Sterling Nominal Effective Exchange Rate (NEER) appreciated about 8% between the low on 11th October and end-November, suggesting the FX market has already priced out the more negative scenarios for the UK economy, whatever they may be (see Black swans and white doves, 8 December 2016). But the Sterling NEER has been range bound since early December, which I attribute to the many layers of uncertainty the British government and ultimately the FX market still face.

Olivier Desbarres - The A Team Fig 1 and 2

Mixed UK macro data may not provide Sterling with much direction

Moreover, UK macro data, which have been mixed in recent weeks, may not provide Sterling with a clear direction either way.

  • The UK trade deficit on goods and services shrunk markedly in October to £2.0bn thanks to the 10% year-on-year rebound in the Sterling-value of exports outstripping the 4.4% yoy increase in imports (see Figure 2). But in the three months to October, imports rose at a seasonally-adjusted annualised rate of 20% quarter-on-quarter, while exports rose only 7.2% qoq, resulting in the trade deficit widening to £13.2bn from £8.5bn in the three months to July. As the Office of National Statistics correctly pointed out, it is simply too early to ascertain whether Sterling’s depreciation and greater competitiveness will have a lasting, positive impact on the UK’s external accounts.
  • The service sector is proving robust, but construction and in particular manufacturing are struggling. The services PMI rose to 55.2 in November and while the construction PMI edged higher, construction output contracted 0.9% mom in October. Manufacturing output was broadly flat in the three months to October (see Figure 3) and the small downturn in manufacturing PMI to 53.4 in November does not point to a sharp recovery in output. The broader measure of industrial output, which includes mining, was down 2% in the three months to October.
  • The UK labour market remains robust on the surface, with the unemployment rate having fallen to an 11-year low of 4.8% in September (see Figure 4). But wage growth has cooled, a point emphasised by Bank of England Governor Carney. Real weekly earnings rose 1.7% yoy in Q3 versus a 2.2% yoy increase in Q2.

Olivier Desbarres - The A Team Fig 3 and 4

Olivier Desbarres

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

 


[1] My understanding is that it would require a unanimous decision by all 28 EU member states to reverse the triggering of Article 50.

[2] In the previous 12 referendums held in the UK, Scotland, Wales and Northern Ireland, Parliament never voted differently than the referendum result.

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