Saturday 21 September 2019

Pro-brexit May replacement could plunge UK into further chaos

UK Prime Minister Theresa May. Photo: Bloomberg
UK Prime Minister Theresa May. Photo: Bloomberg

Conall Mac Coille

In the aftermath of the six-month extension to Article 50 in April, European Council President Donald Tusk had pleaded with the UK parliament to not waste the additional time. However, political developments last week show the UK parliament is highly likely to do just that.

Sterling gained ground early last week, the exchange rate falling below 85p against the euro ahead of planned 'crunch' talks between the Conservative and Labour party, apparently intended to finally settle on a cross-party consensus for a "temporary customs arrangement", and supposedly taking on extra impetus from both parties' local election losses.

Not surprisingly, agreement between the parties has not been forthcoming. With the Government now admitting the UK will have to participate in EU elections, the pressure for a deal has ameliorated. The next official target date is now August 1 - which will almost certainly slip.

In any case, Labour Party leader Jeremy Corbyn was never likely to commit to a cross-party deal, under pressure from his lieutenants Keir Starmer and John McDonnell to press for a permanent customs union. Up to two-thirds of Labour party MPs back a second referendum - and would likely revolt were Corbyn to attempt to strong-arm a Brexit deal through parliament.

And, of course, the split in the Conservative party remains. A temporary customs arrangement wouldn't negate the need for the backstop, ensuring opposition from the Democratic Unionist Party and hardline Brexiteers in the European Research Group (ERG)

Meanwhile, May becomes ever less credible as Prime Minister with every passing day. Last week the 1922 Committee of backbench Conservative MPs put off a rule change to allow an early leadership challenge. However, they are probably keeping their powder dry until after the European elections, when calls for May to resign will only intensify.

Perhaps a three-year stint is the minimum of amount of time May sees as a respectable period in Downing Street. Repeated efforts to force her deal through now look like stalling tactics, merely intended to take-up time until the third anniversary of her premiership in July. Hence, moves to finally force May out of Number 10 look likely to come to fruition during the summer, allowing time for a leadership campaign, with Michael Gove, Jeremy Hunt, Savid Javid, Dominic Raab and Boris Johnson all in the running, before the clock ticks down to October 31.

Our consistent view in Davy since the 2016 referendum has been that a 'fudge' of some sort on Brexit was always likely, keeping the UK inside the EU single market so that tariffs would not be imposed on April 1. This scenario has been come to pass, with the six-month article 50 extension. The question is, will the UK manage to fudge again in October?

In hindsight, the shape of the UK cabinet and parliament meant that a 'no-deal' Brexit on March 29 was never likely. It was only a matter of time before more pragmatic members of the cabinet such as David Gauke and Amber Rudd forced May into committing to a parliamentary vote to extend article 50. Once they had done so, May's strategy of running the clock down to secure further concessions from the EU was entirely discredited.

However, it is now possible that a 'pro-Brexit' candidate for the leadership could run on 'no-deal' ticket - committing to Conservative party members that the UK will leave the EU in October, whatever the circumstances. A leadership contest could be concluded by July or August - giving UK civil servants only limited time to impress on the new prime minister the dire consequences of a rash exit.

That said, any new PM will soon appreciate their tenure will come to an abrupt end in a no-deal exit, given the chaos that would inevitably ensue. That May provides a convenient scapegoat for another article 50 extension, coupled with a healthy sense of self-preservation, should ensure that even a pro-Brexit candidate such as Johnson or Gove will eventually decide to kick to touch.

Slow-burn economic pain

There is no doubt the chaos in Westminster is weighing on the UK economy. Some of the pain of the uncertainty may have been put off by companies spending to build up inventories ahead of the March 29 deadline, fearful of tariffs and trade disruption.

However, business investment continues to contract, employment has slowed and surveys such as the Purchasing Manager Indices suggest growth will slow through 2019.

So it's hardly surprising Bank of England Governor Mark Carney struggled to convince investors that rates should rise faster than the one 25-basis-point increase markets had priced in over the next couple of years.

One vulnerability could be the housing market. Once again the vast majority of estate agents in April's RICs survey reported falling prices, a net balance of -23pc, with London, the south-east and south-west reporting the sharpest falls.

According to Rightmove UK, house price inflation is already in negative territory. This could eventually convince UK consumers to tighten their purse strings, removing the key support of household spending from GDP growth.

That said, given that the immediate threat of a no-deal has been eliminated, business and consumer sentiment could bounce back. This is also true in Ireland, where the ESRI/KBC measure of consumer confidence fell to a four-year low in February. Nonetheless, with core Irish retail sales up 6pc in the first quarter of 2019, there appears to have been little impact on consumer spending so far.

However, just as in the UK, the uncertainty is hurting Irish business investment. After a decade of debt paydown and balance sheet repair, investment by Irish indigenous companies remains weak. Surveys by both AIB and Bank of Ireland show that many Irish SMEs have put off expansion plans due to Brexit.

When I have it, I spend it

Last week saw not only the announcements on the national broadband plan, but also media commentary that Finance Minister Paschal Donohoe was struggling to rein in exuberant expenditure, with his cabinet colleagues eyeing an election in the near future. Moreover, another budget over-run in the HSE looks likely this year, with trade unions now speculating the Government will soon cave in to further public sector pay claims.

It is often forgotten that Ireland voted for responsible budgetary policy in the referendum on the Fiscal Compact in 2012. It may seem naive, but one intention was to allow individual EU countries buy into fiscal rules, rather than seeing them as imposed by Brussels.

However, prudent budgetary policy only tends to be popular during the bust, when households' finances are feeling the impact of tax rises and spending cuts. Now the economy is doing well under its own steam, there is no end to the cacophony of competing voices looking for additional resources, which, if successful, will threaten to overheat the economy - risking a repeat of some of the mistakes from the Celtic Tiger era.

Budget 2019 was hailed by some as prudent, targeting only a 4pc rise in current expenditure. However, as in 2018 the out-turn will probably be closer to 6pc. The Department of Finance's forecast that gross voted current expenditure will only rise by 2.5pc in 2020 and 2021 also looks overly optimistic.

In real terms these would be marginal increases in government spending, given the rate of inflation is already 1.7pc. They would imply the majority of increases would be eaten up by higher pay and other costs, rather than improvements in public services. Political pressure will clearly be for more substantive increases, well above 2.5pc.

If so, the Government may make little progress in growing its small budget surplus, failing to run more substantial buffers to reduce public debt.

It highlights the fact that there is still much work to do to safeguard the public finances.

Conall Mac Coille is chief economist at Davy

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