Tuesday 23/07/2019

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Brexit fears likely to intensify

Chief Economist

Exactly three years ago, David Cameron pledged to renegotiate more favorable terms for EU membership and then present this to British citizens in a referendum. The latter could be held any time up until the end of 2017 but Cameron is willing to move faster. The upcoming EU Council meeting (on February 18-19) is important in this respect. Agreement would allow him to launch a campaign to keep Britain in the EU and hold the referendum this summer already.

Most recent polls point to a (small) majority for the ‘leave-camp’. But the final outcome will primarily depend on what Britain can get out of the negotiations with regards to economic governance, competitiveness, immigration and sovereignty. British demands are far from trivial in this respect and it seems unlikely that European policymakers will agree that easily. At the same time, Cameron is likely willing to show he played hard ball so as to avoid accusations that he was not asking much in the first place. Therefore, the debate is likely to intensify over the next weeks and months.

The EU apparatus and regulation is widely perceived as costly and inefficient and the recent Eurozone and refugee crisis alongside the unpredictable long term prospects for the European project have dampened enthusiasm for EU membership even more. That said, it does not want to be completely outside either. After all, access to the common market is valuable for the UK with the EU accounting for more than 50% of its trade. This delicate balance is reflected in the extensive use of ‘opt-outs’ that the UK has negotiated over the years. Examples are the 1978 exclusion of GBP in the Exchange Rate Mechanism (ERM), a prerequisite for euro adoption, and the non-adoption of the Schengen agreement in 1995. Migration is a big theme. The UK would like to see a numerical control of internal EU migrants or a curb on in-work benefits (such as tax credits) but such demands may be very difficult for the EU to accept.

The overall macroeconomic impact of Brexit is hard to quantify. This is because there are several unknowns and macro models fail to capture several channels through which Brexit would impact the economy. Most studies, however, find that the medium-term impact on the UK would be negative and significant (with the most pessimistic scenarios pointing to a permanent loss of more than 10% of GDP). The direct impact on EU economic activity would be smaller. That said, the reputation damage would be severe and add challenges to what seems already an increasingly fragile European project.

Some observers argue that the gloomy picture shown by some surveys should be treated with a huge pinch of salt following the polling fiasco during last year’s elections. Furthermore, they argue that Cameron’s campaign ahead of the referendum will prove successful in convincing the majority of British citizens to remain a member of the EU. That is because a leave-vote would largely be a jump into the unknown. We tend to agree. That said, upcoming negotiations look set to become difficult and a lot is at stake. Risks remain high and the handling of the refugee crisis over the coming months could be an important swing factor. Risks for the GBP, therefore, remain on the downside.

Hans Bevers, Chief Economist and Michiel Verstrepen, Economist.

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