Barnier raises prospect of Brexit breakthrough

Today’s news headlines:

‘Trump plans for second summit with Kim’ US President welcomes North Korean leader’s letter calling for another meeting. (The Financial Times)
‘Tory Eurosceptics fail to agree on Brexit Plan B’ Publication of alternative Chequers deal called off as divisions come to the forefront. (The Financial Times)
‘House Republicans have introduced legislation to lock-in cuts to individual tax rates beyond 2025, a proposal . . . which sends a signal about GOP priorities ahead of competitive midterm elections.’ (MarketWatch)
‘US weighs sanctions against Chinese officials over Muslim detention camps’ (New York Times)
‘Canadian Foreign Minister Chrystia Freeland will meet US Trade Representative Robert Lighthizer in Washington on Tuesday for another round of talks to renew the NAFTA trade pact, an official said on Monday.’ (Reuters)

The Pound was the second best performing currency in the G10 on Monday, supported by economic fundamentals and positive Brexit developments. Rolling three-month UK growth in July was the highest since August 2017. The figure may have been flattered by base effects and one-off factors like the World Cup and hot weather, but it highlighted the resilience of UK services, the increasingly dominant sector for the UK economy.

In the afternoon session, comments from EU chief negotiator Michel Barnier hit the wire that a Brexit deal was ‘realistic’ in six to eight weeks. This is the latest in the trickle of positive Brexit news flow over the last two weeks. Early last week, an unsubstantiated story reported that both the UK and Germany had softened their stances. Last Friday, Barnier was quoted as saying that the UK’s White Paper Brexit proposal was ‘useful’ and that he had loosened his position on the contentious Northern Irish border issue.

The afternoon news flow continued to reinforce the EU’s new conciliatory tone. Barnier commented that the EU has never faced so many challenges and that it was in its ‘common interest’ to build strong ties with the UK. As if to confirm the gravity of the comments, the Guardian newspaper reported EU leaders were expected to announce another Brexit summit for November.

The suggestion of a deal in six to eight weeks puts the October 18^th EU Summit back in focus for a potential agreement. Next week’s Salzburg meeting will also be watched for confirmation of an emergency summit on November 13^th. The finalisation of a Brexit deal at either date would allow the UK government to meet the tight timeline allocated to ratify a deal. The UK parliament must vote on the deal by 21^st January 2019. The EU Parliament and Council must also ratify the deal by 11pm GMT on 29^th March when EU treaties will cease to apply in the UK.

The news flow supports our base case that a hectic EU calendar—EU parliamentary elections in May, a potential standoff on the Italian budget and the EU multiyear budget—combined with the reduced risk of member states following the UK’s example, will allow the EU to soften its stance and reach a Brexit agreement. We expect an orderly, soft Brexit, with the UK’s future relationship with the EU similar to the Ukraine or Turkey option. Sterling should trade higher, with an eventual target of 1.45 against the US Dollar (GBP/EUR) and 0.88 versus the Euro (GBP/EUR), as it becomes increasingly clear our base case is being realised.

For the day ahead, the UK’s July Unemployment Rate and Average Weekly Earnings figures are likely to confirm the UK’s mature recovery, and that if it wasn’t for the elephant in the room—aka Brexit—the market would price in more aggressive Bank of England tightening. Last week’s UK PMI releases reported skill shortages across all sectors; limited labour supply should translate into wage growth. The US August NFIB Small Business Optimism index should continue to show that the US expansion continues without any signs of a slowdown. The index hit its second highest level in its 45-year history in July.