UK reaction: Transition Deal - A "Decisive" Step

David Page, Senior Economist at AXA Investment Managers (AXA IM) comments on the transition deal announced by the EU and UK negotiators today regarding Brexit.

  • EU and UK negotiators announced the agreement of a transition deal.
  • Step must be formalised at this week’s EU Summit.
  • Transition said to last until end-2020, as EU suggested.
  • Progress has been made over EU citizens’ rights and the UK’s ability to negotiate third party trade agreements during transition.
  • The Irish border backstop position remains unresolved.
  • Transition provides some clarity as to the outlook for UK business for nearly three years and should support business investment.
  • The deal provides a more supportive outlook for UK GDP and could encourage the Monetary Policy Committee (MPC) to tighten monetary policy in May, ahead of our current August forecast.  

EU Chief Negotiator Michel Barnier and DEXEU Minister David Davis held a joint press conference today announcing the “decisive” step of agreeing a transition period. In broad terms, the transition phase, intended to last until the end of December 2020, should mean the UK initially continues to operate as though it were inside the EU, until December 2020. This allows governments and businesses a time to adjust to a new framework after leaving the EU. With both parties in accord, this next step will be for this statement to be formally agreed at the EU Summit this week.

We have suggested that the announcement of a transition deal was likely in March. Businesses based in Britain have been clamouring for certainty over the outlook beyond March next year. Insofar as today’s agreement focuses on a 21-month withdrawal, businesses based in Britain now know their operating guidelines for nearly the coming three years. This is likely to be sufficient for some businesses to make investments in the UK and while business investment growth has stagnated in recent quarters (despite accelerating profit growth and strong global activity), we now expect to see some increase in activity. It should also slow UK business “contingency measures” or investments overseas.  

Today’s press conference made clear that some major hurdles remain. Although the UK appears to have largely acquiesced with EU demands for EU citizens’ rights to broadly remain unchanged throughout transition, the EU has agreed to allow the UK to negotiate and sign free trade deals with other parties during the transition, as long as they are not implemented until after transition. However, the largest question still surrounds the Irish/Northern Irish border. No progress has been made here. Both Barnier and Davis agreed that both parties saw the resolution of the border as a priority. They also both acknowledged that a form of “backstop” agreement must be part of the deal. However, with Prime Minister May’s outright refusal to accept the EU’s legal interpretation of December’s agreement over this deal, it is still not clear what such a backstop will be. Moreover, as we have previously discussed: any borderless solution in Ireland could only come about after the resolution of a future trade deal, something we continue to see as difficult within the 21 month time-frame afforded by the proposed transition. While both parties insist that transition will be complete by end-2020, we remain suspicious that transition may in fact persist for longer.   

In the ensuing Q&A session, Barnier repeated that “nothing is agreed until everything is agreed”. The transition phase is one part of the package of negotiations that the UK and other European Parliaments will be asked to ratify at the end of this year. Barnier’s comments remind that the negotiations are a take-it-all or leave-it-all package. As such, rejection of this deal by any of the Parliaments could still see the UK abruptly leaving the EU in 2019 with no deal.

Financial markets reacted to today’s news. 2-year and 10-year gilt yields rose immediately on the announcement by 3 basis points to 0.86% and 1.50% respectively, before retracing to 0.83% and 1.48% at the time of writing. Sterling firmed on the news, rising to $1.405 against the dollar for the first time in a month and EUR/GBP fell to £0.877 – the softest since the start of February. Today’s announcement also likely has some implications for the Bank of England (BoE). While we expect no change at this week’s meeting on Thursday, this removal of downside risk makes it somewhat more likely that the BoE could tighten policy at its next meeting in May, ahead of our current forecast of August.


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