By Stefan Koopman, Rabobank Senior Macro Strategist
The week in Asia and Europe started off with a continuation of 2023’s decidedly positive risk appetite, but this nonetheless faded during US hours. This morning’s handover from Asia trading to Europe is rather weak too, with the Stoxx 600 slipping around 0.6% after reaching a 9-month high on yesterday. The weaker sentiment is ascribed to some hawkish comments from the Fed’s Daly and Bostic; the latter said that US rates need to be raised above 5% and to be held there for “a long time”. Even though Fed policy makers continuously seek to keep expectations of a pivot in check, they haven’t been very convincing at that: swaps markets are currently pricing nearly 50 bps of cuts in the second half of this year. Consequentially, EUR/USD holds well-above 1.07 – the highest in seven months.
The “will they/won’t they”-pivot chatter is likely going to continue for months on end, and will surely be covered in numerous Global Dailies to come, so it's perhaps a good moment to have a look at something else and to have a look of what Brexit has in store for us in 2023.
Investors are forgiven to have missed some of its more recent developments, as it has been a long time since Brexit made headlines that actually affected markets on a day-to-day basis. However, both Brexit and the intense period of politics following it are closely connected to the UK's current multiple crises. One example is the mini-Budget, which was initially touted as the ultimate fulfilment of Brexit by many of its supporters, but turned out to be a disaster when fantasies met realities. Some of the other crises that are at least indirectly Brexit-related include the potentially persistently high level of inflation, the wave of strike action, potential food supply issues, and the risk of a UK-specific energy crisis. These issues are essential for a functional democracy, and even though Brexit may not have a daily impact on markets anymore, the country’s desire for radical changes to the status quo was a tell-tale sign of its structural decline.
The United Kingdom has become, quite literally, the sick man of Europe. Not only has its productivity growth lagged behind that of other G7 countries for more than a decade, its self-inflicted wounds are now also impacting its healthcare system and, in a very unhealthy feedback loop, the supply of labour at a macro-economically highly relevant scale. At the same time, the Conservative party continues to be dominated by incompetent right-wing populists, which limits the ability of some of the better-intentioned but, frankly, clueless technocrats to address these problems: you would think that nearly 50,000 unfilled nursing positions should even convince the most ardent libertarians that their pay is too low. More strike action is coming in the upcoming days, weeks, and months, only further impairing the country’s economic supply.
So, what is the latest on Brexit? How is the current ‘mood music’ in these perennial talks between the United Kingdom and the European Union? The current negotiations centre on the implementation and possible renegotiation of the Northern Ireland Protocol. This Protocol has caused tension in Northern Ireland – where the unionists of the DUP have refused to nominate a Deputy First Minister until it is “scrapped or changed” – as well as between the UK and the EU. The good news on this front is that parties are currently finally working seriously and pragmatically to reach an agreement on the protocol's implementation, with hopes that some deliverables will be achieved in time for the 25th anniversary of the Good Friday Agreement in April. The quarter-centenary would indeed be rather embarrassing if the institutions that were set up under the treaty are non-operational and the cross-community political consensus it aimed to create is visibly broken.
Yesterday, the UK and EU reached an accord to use the UK's data-sharing system to track goods moving from Great Britain to Northern Ireland. This new database provides real-time customs and commercial data on goods, such as agri-food or industrial machinery, being transported across the Irish Sea. It is the first concrete sign of progress in the dispute over post-Brexit trading rules. A continued ‘de-dramatisation’ and serious progress on trade flows and customs checks between Great Britain and Northern Ireland may eventually unlock further progress on a whole host of other issues, such as the deal’s governance and food safety regulations.
It is to be seen whether the current progress will eventually be sufficient for the Northern Ireland unionists to agree to return to the Northern Ireland Assembly, which they currently boycott. The DUP have stated that they will not return until their concerns about the Protocol are fully addressed (although, as we’ve seen in the recent past, tax handouts do miracles). Yes, increased political pressure from US Democrats, who want to see this being resolved before even thinking about a UK-US trade deal, may eventually result in a partial agreement on trade flows between the UK and the EU, but it remains unlikely that such a deal will be comprehensive enough to fully resolve all issues related to the Protocol and to placate the DUP and the Conservative Party’s own hardliners.
Given that it took more than six months to agree something ‘technical’ as data sharing, the most likely outcome at this point seems to be that another deadline will pass with no comprehensive resolution. Even worse, the risk is that if hardly any progress on the issue of Northern Ireland is made in the next few months and if the UK government decides to still pursue its unilateral Northern Ireland Protocol Bill, a whole host of other issues may again resurface. More specifically, the EU will be keeping a close eye on the UK's efforts to eliminate inherited EU laws through the new Retained EU Law Bill, suspecting that the UK may be attempting to gain an unfair competitive advantage with a bonfire of regulations.
In a speech, the Bank of England’s chief economist Huw Pill linked all of the problems described above to the possible “persistence” of inflationary pressures in the UK relative to other economies.
It has indeed often been said that the UK’s unique inflation problem combined the worst of both the US (soft labour supply) and Europe (skyrocketing energy prices) with some UK-specific goods and services market bottlenecks added to it. This should keep inflation elevated throughout 2023
and well into 2024, making a Bank of England pivot a remote prospect. We look for Bank rate to rise to 4.75% by this summer.