MIKE DOLAN: Surprise Northern Ireland breakthrough better news for UK than it looks

London — If the world faces what the IMF dubs “geoeconomic fragmentation”, this week’s post-Brexit breakthrough may be a bigger relief for Britain than lukewarm reactions suggest.

The long-sought deal on post-Brexit trade rules for Northern Ireland, struck between UK Prime Minister Rishi Sunak and European Commission President Ursula von der Leyen on Monday, still needs the agreement of key parliamentary parties and also all groups in that UK-run corner of the island of Ireland.

But the reworking of the controversial Northern Ireland protocol, which Britain itself has agreed to attach to the original Brexit agreement but then insisted was unworkable, surprised many political and financial experts.

And initial soundings on its progress are hopeful.

For markets hardened by at least seven years of back-and-forth over every aspect of Brexit, and for many traders and analysts who tend to glaze over at its mere mention, there has been a tendency to downplay this week’s “Windsor Framework” relative to myriad other pressing problems.

Even though many of those problems may owe something to Brexit itself, which took effect three years ago following 2016’s narrow referendum, the dominant concerns for investors at the moment are double-digit inflation, energy, rising taxes after 2022’s budget U-turn and widespread labour unrest.

It has been a gloomy winter, with much domestic soul-searching. And it was little surprise that the IMF forecast that Britain would be the only economy of the Group of Seven to contract in 2023.

UBS chief investment officer Mark Haefele reckoned that in the short term the economy “remains more sensitive to drivers like heightened rates, higher taxes and macro headwinds”. ING’s strategists concluded “rate differentials are likely to prove more important drivers of sterling than the new UK-EU deal”.

But there is little doubt the pound perked up on what was a rare glimmer of positivity after the dark winter and a year of political, budgetary and bond market chaos. It gained 1.2% and 0.7% this week respectively against the dollar and the euro.

Even though sterling had already recovered smartly from the worst of last September’s government budget farce as the Bank of England and new finance minister stabilised the gilt market, the pound’s trade-weighted index is still down more than 3% since Brexit took effect in 2020 and it is more than 10% lower than it was before the 2016 vote. It is about 13% below the 30-year mean.

The blue-chip FTSE100 — overloaded as it is with international, commodity and banking stocks — has hit record highs this year. But it has also underperformed the S&P500 in dollar terms by about 25% since 2020 and the domestically facing FTSE250 midcap index is 6% lower over that period.

Should there be more to this Brexit breakthrough for markets — not least if Brexit without major new trade deals becomes riskier given the West’s standoff with Russia, deteriorating relations with China and the geopolitics of “onshoring”, “near shoring” and “friend shoring” of supply chains?

“The forces of geoeconomic fragmentation are growing,” the IMF warned in its latest economic outlook in January.

If Britain is a central part of the Nato political and military alliance, then the desire to bind it back in economically too may have gone up a notch in Washington and EU capitals as well as in London.

For markets, that may sound a bit too much like a “counterfactual” — pricing securities based on what might have been.

But certainly the potential for improved trade relations with the UK’s biggest trading partner is clear. The EU already promised it would allow British scientists to rejoin its vast research programme if the deal goes through.

“Over the midterm, an improved EU-UK relationship and reduced risks of trade disputes could be positive for growth,” Haefele at UBS conceded.

Others argue that even this thawing of relations pales compared to Britain’s loss from remaining outside the EU’s single market and customs union — an option even the opposition Labour Party has taken off its manifesto.

Unicredit this month cited estimates that the UK economy will underperform by 5%-7% over 10 years if it remains outside the EU single market and customs union.

And yet one big prize in solving the Northern Ireland aspect of Brexit at least is that it would overcome the biggest obstacle to Britain securing a post-Brexit trade deal with the US. It may even have been a key spur to this week’s breakthrough given the frayed geopolitical backdrop.

President Joe Biden has long insisted there would be no progress on a US deal with Britain until the Northern Irish conundrum is resolved. And on Monday he was one of the first to welcome the Windsor Framework.

Rising momentum behind a UK-US trade deal could be a significant positive twist for the UK — not least as the Western alliance feels the need to close ranks for a potentially protracted freeze in relations with China and Russia.

A report in January by Washington think-tank Center for Strategic and International Studies (CSIS) urged the White House and the US Congress to prioritise a US-UK deal, citing data showing the US accounting for 17% of UK trade in goods and services and Britain the destination for 23% of US digital service exports.

“The overall benefit of a US-UK trade agreement is simple and obvious,” CSIS adviser Meredith Broadbent wrote, adding that about $505bn of direct investment in 2019 made the UK the largest European investor in the US.

“The UK will be a valuable partner for the US on a common and positive free market agenda for the global economy, while simultaneously mitigating the effects of rising bilateral tensions with China.”

Reuters