Rarely has the outlook been quite so uncertain: It is still totally unclear what form Brexit will take. Negotiations between Brussels and London have been completely deadlocked for weeks, and even now, talks are only moving forward very slowly. Admittedly, there are major differences in the interests of both parties in the negotiations. In principle, London wants to square the circle – i.e. it wants the advantages of the single market without the inconvenient obligations which come with EU membership. This is what supporters of the Leave campaign promised and they still hang on to this wishful thinking to this day. An exceptionally precarious political situation in Westminster is standing in the way of greater willingness to compromise. Meanwhile, EU negotiators are sticking almost dogmatically to their view of how negotiations should be conducted, i.e. the question of the Brexit divorce bill must be settled first before talks can begin about future trade relations. As a result of this approach, it was not long before the UK side had its back against the wall: The UK is expected to make substantial concessions but without any hope of some reciprocation from the EU side in respect of key demands. Almost inevitably, this has led to deadlock in the talks.
All this means that completely different Brexit options are still possible, with equally different economic implications. If negotiations fail because Brexit hardliners in London finally gain the upper hand against a weakened prime minister, then the UK would face the prospect of a chaotic Brexit in March 2019 and leave the EU without any deal whatsoever. This is undoubtedly the worst-case scenario since it would mean that import duties would come into force overnight, bringing the economy to a grinding halt: this would be a very hard Brexit. However, the other extreme, an exit from Brexit, is far from being entirely ruled out. Even now, regret is growing among Britons about the decision to leave the EU, and this shift of opinion could be boosted by economic and inflation worries. This would be the best-case scenario for the economy and the resulting catching-up effects in terms of investment and consumption could lead to a strong economic recovery in 2019. An agreement along Norwegian lines would also have the same effect for the economy and could be „sold“ to the mostly Eurosceptic UK people as a face-saving compromise. The Leader of the Opposition, Jeremy Corbyn, is a strong supporter of this „very soft Brexit“ option and could do well in the event of fresh elections with this approach.
A sensible solution would undoubtedly be the best outcome for the negotiations. In our main scenario, which also underpins our current economic forecast, we assume a compromise which would be advantageous for both sides: A customs agreement, modelled on the concept of the customs union and which would come into force after a two-year transition period. During the transition phase, the UK would retain all the rights and obligations which go with the single market, but no longer be a member of the EU.
Advantages: there would still be no tariffs on goods trading; businesses on both sides of the Channel would benefit. The value chain would remain unharmed. The UK would no longer have to pay any contributions to Brussels and would no longer have to accept the free movement of people. However, it would lose passporting rights for banks, which would lead to significant adjustments in the UK financial sector. However, with that option, the EU would have made it clear that it will not accept any „cherry-picking“. Moreover, the transition phase would ensure that any negative impact for the UK economy was spread over time and cushioned; this would be a „soft“ Brexit. The UK economy could recover moderately during the course of 2019 after a fairly weak performance the previous year. The arrangement would also bring movement in the Ireland question, which is currently also blocking the Brexit negotiations, thus avoiding a “hard border” between EU member Ireland and Northern Ireland. A hard border between the two would pose a threat to the precarious peace process in the region.
We only assign a relatively low 50% probability of our main scenario becoming reality. There is a big risk that negotiations will fail, just like the chance of a decisive change of mind among the British people about Brexit. However, there is no disputing the fact that political decisions made in the next few months will have a crucial impact on goal posts for the UK economy. Decision-makers in London and Brussels therefore carry a huge responsibility.