MONETARY POLICY REPORT | WINTER 2021 (box 1)
(authors: Petr Polák, Michaela Ryšavá)
One of the key risks to the economy in Europe until recently was the threat of a no-deal Brexit. Although the referendum had been generally about exiting the EU, the UK’s political representatives decided not only to leave the EU-28, but also to end the almost 40-year long partnership and membership in the customs union and the single market. The agreement on free movement of goods, services and capital thus ceased to apply after the UK left the EU last year. If no new trade agreement had been reached, trade relations between the two jurisdictions would have started to operate under World Trade Organisation terms at the end of the transition period on 1 January 2021. However, given the significant interconnectedness of the two economies (see Chart 1), this would have resulted in losses on both sides.
Chart 1 – The two economies need each other
Goods exports from EU to UK and vice versa in 2019; shares in total exports in %; source: IMF
The threat of a sudden interruption of EU-UK trade flows has had major impacts on the financial markets more than once in the past. Growing fatigue due to the very slow progress became apparent on both sides in December 2020. Uncertainty increased in the financial markets and the bets on a no-deal Brexit prevailed (see Chart 2). The fear of supply disruptions sparked panic among British and EU firms, leading them to hastily engage in stockpiling before the year-end. The UK postponed the exit date at the last minute several times following the Brexit referendum in June 2016. On each occasion, this led to stockpiling by trading partners, as evidenced by data on the numbers of trucks transported through the Eurotunnel (see Chart 3) and by maritime freight traffic data collected at ports.
Chart 2 – The protracted negotiations increased tensions on financial markets
Source: Bloomberg
Chart 3 – Before each key Brexit deadline, firms stockpiled and Eurotunnel traffic increased
Numbers of trucks transported in given month; source: https://press.getlinkgroup.com/news/
Note: 6/2016: Brexit referendum; 3/2019: original Brexit date based on time limit of two years after activation of Article 50 of Lisbon Treaty; 10/2019: UK meant to leave EU but date postponed again to January 2020; 12/2020: EU and UK sign trade deal.
After nine months of negotiations, the UK and the EU finally managed to reach a compromise and strike a trade deal on Christmas Eve 2020. Mutual trade will not be subject to tariffs and quotas. In the case of movement of people, short-term trips of up to 90 days will still be possible, but visas will be required for longer visits. In the disputed areas that had been blocking the negotiations, the UK succeeded on only a few points. It had its way in the area of competition, i.e. it can now set its own standards and provide government support. The countries ultimately also agreed on a neutral committee to oversee dispute resolution. Conversely, the UK backed down on fisheries, so EU fishermen will only have to give up one-quarter of their current catch in British waters for the next more than five years. Other concessions relate, for example, to security. A big change will also take place in education, with the end of cooperation in the Erasmus exchange programme.
However, the agreement did not provide any relief for financial firms, which needed to maintain automatic guaranteed access to European financial markets and sale of financial services from London to the single market (after losing the single passport). One-sixth of the UK’s financial and insurance services depend directly on demand from the EU single market. Further negotiations will also be required in the area of electricity trading, as the UK is no longer part of the European single energy market.
The initial relief upon signing the agreement is quickly dissipating amid the first difficulties with the transport of goods. The delays are mainly due to increased paperwork and border controls. The UK’s customs systems are not operating as smoothly as expected either. This presents difficulties mainly for foods that need to be transported quickly. Some companies (Marks & Spencer, for example) have responded by suspending supplies to the continent. Firms are also struggling with taxation changes and “country of origin” rules, i.e. uncertainty as to whether imported goods are subject to customs duty. These difficulties are being reflected in higher transport costs. Shipping data from the beginning of January meanwhile indicate significantly lower interest in cargo services than is typical of this time of year. It will take some time before trade between the EU and the UK becomes fully operational. This will dampen the UK’s economic recovery. However, the EU partners of UK companies are also facing lower orders. At a time of pandemic, this has worsened the outlook for the hitherto resilient European industry. That said, the outlook is still better than it would have been if the UK had left without a deal.