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06.02.2020 7 BREXIT THE economy has been on the verge of recession recently. Whether it im- proves as Brexit uncertainty lifts largely depends on the UK government's ap- proach to negotiations with the EU and the progress it makes. If it can avoid headlines about looming tariffs, then business confidence and in- vestment can recover. What risks remain? During the current transition period, the economic relationship between the EU and UK is largely the same as before but the UK will no longer take part in the political processes of the EU. Both sides will negotiate the rules and pa- rameters of the future relationship, in- cluding trade. 2019 was a torrid year for the UK as the economy and investors struggled with the high degree of uncertainty gen- erated by political deadlock on Brexit. With best efforts being made to prepare for the worst possible outcome, the risk of a sudden stop to trade and possible shortages of goods was a real danger. It still is. In the absence of a trade agreement or an extension to the transition deal, the UK could be facing the same no-deal or cliff-edge Brexit at the start of 2021. How might the UK approach negotiations? Talks on the future relationship will begin in spring. ey will start by con- sidering issues such as: What should happen if the UK decid- ed to diverge from the EU's common standards? What happens should the EU choose to change those standards? Will the UK be consulted beforehand? Who decides whether either side has broken the agreement? What will be the consequences of breaking the agreement? Once these issues have been resolved, talks can become more granular. At this stage, we expect the UK gov- ernment to pursue a sector-by-sector approach to negotiations, rather than an all encompassing deal. is is be- cause the EU will not want the final outcome to resemble full single market access if the UK is not willing to agree to the free movement of people. Moreover, full membership of the customs union is impossible if the UK wants to pursue independent trade deals. e UK is likely to prioritise manufac- turing sectors, in particular, the auto in- dustry, chemicals and machinery. Trade in services is likely to be excluded, part- ly due to the complexity and lack of available time. Where the UK is less likely to achieve a complete deal is for the trade in agricul- tural products. Not because the trade in dairy and livestock is complicated, but because it competes with other member states, in particular France. Some of the highest external tariffs that the EU plac- es are on agricultural goods, for exam- ple, 45% on dairy products, or 21% on beverages and tobacco. A sectoral approach, rather than "all- or-nothing", may reduce the risk of a no- deal outcome at the end of the transi- tion period. e UK government could claim a victory, even if some sectors are excluded in order to meet the deadline. Sectors that are excluded are likely to face tariffs, but they may be compensat- ed by the government. e UK might push for a new transition agreement for these sectors to limit the impact on businesses, with a view of agreeing a "phase-two" deal to cover them. Phased trade deals are all the rage at the mo- ment. Meanwhile, the UK can start negotiat- ing its own trade deals, although these cannot come into effect until after it leaves the EU's customs union. e gov- ernment is already working on replac- ing many of the existing EU trade deals with third parties that will soon lapse. Will economic activity rebound? Brexit-related political uncertainty weighed heavily on the UK economy in 2019. Business investment shrank through most of the year amid concerns over the risk of disruption to trade, while even households curbed their spending. With Brexit now certain and a trade negotiation underway shortly, could we see a rebound in activity? ere have been some positive signs. e flash Markit purchasing managers' indices (PMIs) for January showed a notable jump. e PMIs survey compa- nies in the manufacturing and services sector to gauge activity in the economy. 50 is the level that separates expansion from contraction. e manufacturing PMI rose, albeit still remaining below the neutral 50 lev- el. Encouragingly, the new orders indi- cator returned to positive territory. e services PMI also improved, with both the business activity and new business indicators leaping to their highest levels since September 2018. While these signs of a rebound in ac- tivity are positive, it will take some time for the official data to catch up. A signif- icant handicap in the short-term is the build-up of inventories (or stockpiles) which took place last year to protect against a no-deal Brexit outcome. In- ventory levels are now being reduced but they still remain high. is means the recovery in production and output could be delayed while inventories are run down. is suggests GDP may not rebound much before the second half of the year. However, once it does, the UK should enjoy above average growth through at least 2021. However, the recovery will depend on the UK government's ability to make progress in trade negotiations, and equally as important, avoid brinkman- ship in negotiations. If businesses see headlines about World Trade Organ- isation (WTO) tariffs looming, then currency volatility will return, and busi- nesses will retrench. Can the UK economy rebound after Brexit?

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