Samantha Amerasinghe outlines growth prospects for the European economy

Trade will be a key focus next year, particularly given the uncertainty surrounding Brexit and the unexpected outcome of the US presidential election. It is highly uncertain what the UK’s future would look like outside the European Union (EU), but the impact of Brexit is likely to be negative for its economy.

Uncertainty means that many business decisions have been put on hold, and consumers might be hit by stalling job growth and higher prices over time.

The Sterling Pound (GBP) has come under pressure from economic weakness, policy easing and political uncertainty. In the immediate aftermath of Donald Trump’s election victory, it stood at 1.24 against the US Dollar but we expect downside risks in 2017. The GBP has depreciated by approximately 20 percent in trade-weighted terms since the end of last year and about two-thirds of this erosion followed the Brexit vote.

We expect growth to slow next year to 0.5 percent and remain weak in 2018, as business sentiment remains subdued during formal EU withdrawal negotiations.

Britain’s Prime Minister Theresa May has made it clear that “Brexit means Brexit,” and promised to trigger Article 50 by end-March 2017. But with last month’s High Court ruling on the need for a parliamentary vote to begin the withdrawal process, the government appears set for a fight as it has appealed against the verdict.

Trade and immigration are likely to dominate negotiations. There will be a two-year window in which to negotiate the terms of Britain’s exit from the bloc, suggesting the UK leaves the EU by the second quarter of 2019 – before European parliamentary elections in May that  year. This can only be extended with the unanimous agreement of all 28 member states.

Brexit is a leap into the unknown. ‘Hard Brexit’ – taking Britain out of the EU’s single market – is now looking more likely, given the opposition to the free movement of labour.

So what are the advantages and disadvantages of the most likely trade options for the UK?

One option, although less favoured by ‘Brexiteers,’ is to join the European Economic Area (EEA) as Norway has done. This option would mean a ‘soft Brexit’ in which the trade costs of  the exit are minimised as the UK remains in the single market. It would involve paying about 83 percent as much towards the EU budget as the UK currently does and maintaining existing EU regulations.

A second option is to negotiate bilateral deals with the EU while maintaining migration control as Switzerland has done. Switzerland has free trade and over 120 agreements that give it access to the EU’s single market for most of its industries, but it faces regulation without representation and pays about 40 percent as much as the UK to be part of the single market. However, the UK is a major exporter of trade in services, an area in which the Swiss have no agreement with the EU. So its arrangement will likely differ.

A further option is to enter into a customs union – i.e. an agreement to share common external trade relations with other countries – or a free trade agreement (FTA). If the UK leaves the EU single market and opts for a customs union with it, it would permit tariff, border and rules-of-origin-free trade in goods between the UK and EU.

However, this option would curtail the UK’s ability to negotiate its own free trade deals. It would have to accept trade deals that have been sealed by the EU and provide access to the UK without automatic reciprocity.

If the UK leaves the EU customs union, its priority will be to establish an EU trade deal, given the importance of that market for British exports. But it will then also seek free trade arrangements with other countries such as China and the US, its most important non-EU trading partners.

An EU deal would be difficult to achieve as it would require unanimity from EU 27, as well as national ratification and support from the European parliament. The UK would also have less bargaining power than the EU in its deals with other countries, which could be costly for Britain.

If no FTA is in place, the UK will need to independently operate under World Trade Organization (WTO) rules. This would offer Britain more sovereignty, at the price of less trade and a larger fall in income, even if it abolishes tariffs completely.

The spotlight on trade will also be a key focus in the US, post the election of Donald Trump. President-elect Trump has taken tough stances on several trade issues such as opposing ratification of the Trans-Pacific Partnership (TPP) and strengthening the enforcement of trade obligations, especially with China.

Although a US-EU agreement has lost some of its shine post Brexit, with the UK leaving the EU, it could offer significant benefits to the US economy. But what Trump has in mind, and is likely to do, is left to be seen.