Is the UK government heading towards a softer Brexit?

The joint progress report leaves several options open for the UK but phase II of negotiations is likely to prove at least as difficult as phase I.

12-08-2017
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Authors

Azad Zangana
Senior European Economist and Strategist

The UK and European Union (EU) have agreed on a joint progress report on citizens’ rights, Northern Ireland, and the divorce bill. This is expected to allow the EU Council to recommend opening the second phase of negotiations.

Most of the details on citizens’ rights and the divorce bill had already been agreed, but the Northern Ireland (NI) border issue had been a significant obstacle, especially as the government is reliant on the NI Democratic Unionist Party (DUP) for its majority in the House of Commons.

At this point, the NI issue is still unresolved, but the report has outlined principles which all sides have agreed to and which help form the resolution to the problem.

These principles also act as constraints for the UK’s position in phase II, where negotiations will move on to the future relationship along with all other aspects of the divorce, including a transitional or implementation period, and a framework for a future trade agreement.

Door remains open to EEA membership

The principles outlined in the report state that the 1998 NI peace agreement will be respected by both sides, and so the UK will guarantee the avoidance of a “hard-border”, presumably through the use of technology.

Should it not be possible to reach a solution to this in the context of the overall EU-UK future relationship, the UK “…will maintain full alignment with the rules of the Internal Market and the Customs Union, now or in the future…”.

This suggests that the UK still believes that it can achieve some kind of “bespoke” arrangement, although, as things stand at the moment, the EU27 will probably take the view that this would involve the UK agreeing to membership of the European Economic Area (EEA).

EEA membership could be problematic for Brexiteers, as “alignment” or even membership of the single market would require free movement of labour, while the customs union would stop the UK negotiating bilateral trade deals with other parts of the world.

Could Northern Ireland have special status?

There could be another route should the UK struggle with the above. The report goes on to state that “in the absence of agreed solutions…the UK will ensure that no new regulatory barriers develop between Northern Ireland and the rest of the UK…”.

The text does not mention the avoidance of regulatory divergence, only barriers. This could lead to a scenario where the NI becomes a special economic zone, which adheres to EU rules to allow for full access to the Republic of Ireland, but can diverge from the rest of the UK.

However, the UK would have to respect the rules in NI, in order to continue unfettered access to the rest of the UK. In a sense, NI could end up being the back door to the EU and UK.

Two other elements of the text are worth mentioning:

  • Under the 1998 peace accord, those born in Northern Ireland have the right to choose whether to take British citizenship, Irish citizenship, or both. Both sides have agreed for this to continue, and will therefore provide a way to also gain EU citizenship. We suspect this could lead to a new birthing-tourism industry in NI.
  • Under the section of citizens’ rights, both sides will have the right to bring over immediate family members regardless of nationality (including non-EU). This could prove to be difficult to accept for UK anti-immigration groups.

A long and winding road remains to Brexit

Overall, the details of the progress report highlight the immense difficulty of the UK leaving the EU without a substantial agreement, and while continuing to adhere to the terms of the 1998 NI peace accord.

It shows a desire and willingness on both sides to progress the discussions, but in fairly traditional EU style, leaves many cracks papered over for now. This suggests a softer Brexit may be the easier path to follow for the UK government, especially if it wants to maintain its majority in parliament.

Meanwhile, negotiations will move on to include the framework for a future trade relationship. Trade will easily be as contentious as negotiations in phase I, with EU officials already warning that it is unlikely that a full agreement can be completed in time for Brexit in March 2019. Moreover, establishing a transition or implementation period could also be legally difficult to agree.

Progress so far should be seen as positive, but there is still a long and winding road ahead.

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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.

Authors

Azad Zangana
Senior European Economist and Strategist

Topics

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