Dear Pound Sterling Investors, Keep Calm and Carry On

The pound fell to a 30-year low against the dollar on Monday, after British Prime Minister Theresa May said she had no intention of keeping “bits of membership of the EU” after Brexit.

The comment was widely interpreted as meaning that Britain would leave the European Single Market as part of Brexit negotiations, and the pound’s sharp fall suggests investors see this as an economic blunder.

However, while the British electorate voted for Brexit in June 2016, nothing has actually changed yet. What’s more, the British economy has consistently defied expert predictions of post-referendum gloom — services, manufacturing, and construction sectors are all growing strongly, and the benchmark FTSE-100 share index is hitting record highs.

In light of this, currency speculators’ pessimism seems somewhat premature. The unhappy Brexit their sterling sell-off implies is certainly a possibility, but it’s not the most likely one. So let’s step back and look at how things might play out over the months and years ahead.

The British government is awaiting a Supreme Court decision on whether it can unilaterally trigger Article 50 — the legislative clause formally signaling Britain’s intention to leave the EU, which would begin the two-year period of UK-EU negotiation — or whether parliament must have a vote. The Court is expected to rule in favor of a parliamentary vote sometime in January.

At that point, the British government will quickly bring forward Brexit legislation, aiming to trigger Article 50 before the end of March. That legislation ought to pass the House of Commons without too much trouble — not least because Theresa May could use any legislative intransigence to engineer an early general election that her party would win handsomely.

The unelected House of Lords could be a different matter, however. While the upper chamber cannot realistically block Brexit, they may seek to delay it, or else use their influence to reshape the government’s negotiating principles.

What of those principles? The government has yet to fully articulate its Brexit strategy, but the broad outline of its approach is easy enough to discern. First, the government is determined to restore national control of immigration and to end the supremacy of European Court of Justice rulings over British law.

That rules out continued membership of the Single Market, which requires free movement of people and imposes a unified regulatory regime across the European Economic Area.

Second, the government wants the freedom to negotiate new trade deals with non-EU countries. That rules out continued membership of the EU customs union, which puts a common tariff on all imports from outside the bloc.

Third, the government wants UK-EU trade in goods and services to be as free as possible after Brexit. Taken together with the preceding points, that suggests Britain will pursue an extensive bilateral trade agreement with the EU.

There’s no reason why such an agreement should not be reached. Britain and the EU both have a strong interest in continued trade. Moreover, they are starting from a position in which free trade already exists to a very large degree.

There are no significant regulatory differences to iron out and no subsidy-hungry special interest groups to placate. In other words, few of the policy issues that bedevil most trade agreements apply.

Politics may be the biggest challenge. For one thing, any bilateral agreement could require the assent of numerous national (and even regional) electorates across Europe — approval that cannot be taken for granted.

EU negotiators may also attempt to discourage other EU member states from following in Britain’s footsteps. This suggests Britain may have to suffer some form of punishment for leaving the EU, with London’s lucrative financial services sector the most likely target for continental ire.

For its part, the British government will face significant pressure from its own MPs — as well the media and the general public — not to back down easily; many would prefer that Britain walk away with no deal, rather than settle for a humiliating one.

That raises the specter of a truly “hard” Brexit — a clean break after which Britain would trade with the EU like any other country, in accordance with World Trade Organization rules.

That scenario is still unlikely to come to pass. In the short term, it would be extremely disruptive (not to mention economically damaging) for both sides; negotiators will surely work hard to avoid it.

In the long run, though, even a hard Brexit need not be disastrous for Britain — any losses it generated could be balanced out by a genuine commitment to radical policy reform at home, coupled with a concerted effort to liberalize trade overseas.

It remains to be seen whether the British government has what it takes to make necessity the mother of invention. In the meantime, however, investors would be wise to remember the old adage about keeping calm and carrying on.

This article appeared in The Hill (Online) on January 12, 2017.

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