UK: Some Brexit clarity at last? - ING

The UK government has finally managed to craft a Brexit compromise that ministers can rally around, but the proposals have been met with a cold reception in Brussels and pressure is building on the Prime Minister to look more closely at a customs union, suggests James Smith, Developed Markets Economist at ING.

Key Quotes

"Managed divergence" - The UK's proposed Brexit

• For several months now, key ministers in the UK government have been heavily divided on the way forward on Brexit. But after a marathon 8-hour “Brexit away day”, Prime Minister Theresa May has reportedly agreed on a compromise which can unite the key factions within the cabinet. The compromise reportedly goes by the name of “managed divergence” (or “Canada plus plus plus”). We’ll have to wait until PM May’s speech on Friday for the full details, but it's assumed that this model would involve dissecting different areas of economic activity into three baskets.
• The beauty of this, in theory, is that there’s something for everyone. “Remain” ministers would be happy because it would allow the UK to remain closely aligned to the EU in key areas. And for the “Brexiteers”, it allows the government to “take back control” of regulation where it perceives EU rules to be burdensome.
• Of course, it’s one thing getting UK ministers on board. Getting the EU to agree to such a proposal looks much more challenging, and in fact, the European Commission published a slide last week saying it is “not compatible” with its guidelines.”

“Cherrypicking is a big EU concern

• From the EU’s perspective, the managed divergence proposal sounds a lot like cherry picking – a key red line for European governments, who are strongly opposed to allowing the single market to become divided up.
• There are also reportedly fears that it could result in a backlash from the EU’s other key trading partners. A deal that enables the UK to excel after Brexit could embolden members of the EEA to request concessions of their own, or even make EU exit seem more appealing to some of the more eurosceptic existing member states. European negotiators will also be acutely aware that whatever both sides agree on services would also have to be offered to existing free trade partners (e.g. Canada and South Korea) under most-favoured-nation clauses.
• There are practical considerations too. Reconciling the differing views of the 28 countries involved in the negotiations on exactly what sectors/areas would sit in each basket would be a very complex and time-consuming task.
• But perhaps the biggest issue is that the "three baskets" approach is unlikely to mitigate concerns over a hard border with Ireland. As part of the phase I agreement back in December, the UK agreed that there would be "no regulatory divergence" between Ireland and the North. The UK's government's decision to leave the customs union, and preference to move away from certain EU rules after Brexit may not be enough to meet December's commitment.”