UK Article 50 Notification Begins Challenging Negotiation

The UK’s notification of its intention to withdraw from the EU sets the stage for a challenging negotiation process with a wide range of possible outcomes regarding trade and institutional arrangements, Fitch Ratings says.

The UK has triggered Article 50 of the EU Treaty, which envisages that the Treaty will cease to apply to the UK when a withdrawal agreement comes into force, or failing that, two years after notification (unless the other EU 27 members unanimously agree an extension). EU 27 leaders will meet in late April to discuss their negotiating position.

The uncertainty created by the EU referendum is a sovereign rating weakness for the UK (AA/Negative). But the wide spectrum of possible outcomes from negotiations means the rating is not predicated on any particular base case. Our analysis will focus on the impact of Brexit talks and their outcome on growth, public finances and the UK’s political integrity.

The number and complexity of issues to resolve, and the multiple national interests involved will make the negotiations difficult. There is no precedent for leaving the EU, and the UK will not be in control of the negotiating agenda. Two years is a short time to reach a free trade agreement (one of the Brexit aims set out in Prime Minister Theresa May’s 17 January speech), and the time available may be less if the terms of the UK’s withdrawal, including any “exit bill” relating to items such as budget commitments and staff pensions, have to be agreed first.

Domestic political challenges include the lack of a unified national position on Brexit, potential shifts in public opinion, and the Scottish government’s current intention, backed by a vote by the Holyrood parliament, to hold a second independence referendum.

The UK government has ruled out continued membership of the single market or the full EU customs union. An exit agreement could include a period of continued preferential access to the EU single market extended beyond the two years provided for by Article 50 to give more time for trade arrangements to be finalised, although this could imply the “four freedoms” of the EU, including freedom of movement, also being extended beyond the two years.

But it is possible that the UK fails to secure a future trade relationship with the EU or agreement for an implementation phase in the two years of negotiations, and reverts to WTO terms. The “cliff effect” and likely shock to the UK economy made a WTO scenario the most negative of the three hypothetical Brexit trade scenarios we examined in December last year.

The UK has not experienced an abrupt economic slowdown since the EU referendum, but our GDP forecasts reflect a weaker investment outlook due to uncertainty during the negotiation period. They also incorporate slower consumer spending growth due to higher inflation following the depreciation of sterling that occurred after the referendum. These effects are partially offset by better prospects for net trade given the weaker pound. We forecast UK GDP growth to slow to 1.5% in 2017 and 1.3% in 2018, and consumer price inflation to rise to 2.8% by end-2017 before falling back slightly to 2.6% by end-2018.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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