End of part one

The news early this morning that the EU has agreed that “sufficient progress” has been made following the first phase of Brexit negotiations was initially met with a positive market response. But with sterling eventually weakening in the course of the day it is evidently not being seen as a panacea for all Brexit ills. Whilst there was compromise on both sides, the UK has moved far closer to the EU’s initial position, particularly on the question of the exit bill, which is pretty much what we thought would happen all along. Meanwhile, the Irish border question has been kicked down the road for now.

With regard to the bill, the official document released today did not attempt to put a figure on the final cost but it is estimated that the UK will pay a net amount between €40-60bn over a multi-year horizon (we assume €50bn for the sake of argument). It will also continue to pay into the EU budget in 2019 and 2020 as if it were still a full EU member. On the basis that the annual net cost of membership is around €8bn per year, this implies that around one-third of the net exit bill will be paid by 2020. But this still means that the UK will have to find an amount equivalent to €35bn after 2020 – the equivalent of 4-5 years of full membership. In practice, it will have to pay a lot more up front. Some of the reimbursements, such as the share of European Investment Bank assets, will only be repaid over a twelve year period beginning in 2019.

The fact that the UK will continue paying into the budget until 2020 resolves a major headache for the EU, since this allows it to meet all obligations in the current budget cycle which would otherwise have been interrupted had the UK ceased to pay in 2019. But it is bad news for the UK, which will become a rule taker whilst still continuing to pay full membership fees. The UK is thus moving towards the Norwegian option – at least in the short-term – which I pointed out in the immediate  aftermath of the referendum was the worst option because it imposes all the same costs without the benefit of being able to influence the rules.

It is unlikely to be a long-term solution, however, with the EU increasingly of the view that a Canadian style free trade agreement is the most plausible option. Whilst such an outcome will offer largely tariff-free trade in manufactures, replication of the Canadian option implies some tariffs would remain on agriculture and it would permit no access to EU FTAs with only a partial liberalisation of services. Moreover, there would be no financial services passporting. But it will take many years to hammer out such a final deal – do not be surprised if the EU and UK seek to extend the Norway option for another two years to 2023 whilst they continue to work on the details of the final arrangement.

Earlier this week, the Irish border question threatened to derail any prospect of reaching a deal today. No resolution was offered this morning. The issue has merely been kicked down the road. Indeed, the problem of avoiding a hard border remains incompatible with leaving the customs union and single market, and the best that the two parties could come up with was that if they fail to resolve the terms of their future relationship, the UK will maintain “full alignment” with the EU internal market and customs union rules which “now or in the future” are important for preserving north-south trade. Despite the DUP’s recent objections to treating Northern Ireland differently to the rest of the UK, that in effect appears to be what is being proposed in the absence of an alternative.

What to make of it all? Firstly, we should welcome today’s events as a first sign that progress towards a trade deal – and ultimately a softer Brexit – has been made. But it comes at a price: the UK has capitulated in the face of the EU’s demands, thus rendering irrelevant the six months of bluff and bluster by Brexit supporters. In no sense has the UK taken back control: Indeed, quite the opposite since the Norwegian solution implies giving up lots of control. Nor has it freed up the additional funds that were promised to the NHS (£18bn per year if you recall).

But it could have been worse. The Brexit Secretary finally admitted this week that “no economic impact study had been undertaken before the cabinet decision to leave the customs union and no assessment had been made of the possible economic effect of a no-deal Brexit”. At least they now have the time to do some impact analysis to assess the costs of Brexit. One of the arguments often used by Greek and Italian citizens for remaining in the EU is that it forces their politicians to act responsibly. Today’s deal may have given UK politicians a lifeline they were too disorganised to find for themselves.