The Conservative Party government has indicated that it will trigger Article 50 of the Lisbon Treaty by March 2017, thereby initiating a two-year period of negotiations to establish the terms of the UK’s new relationship with the EU following the decision of British voters to leave the bloc at a referendum held in June. Prime Minister Theresa May, who was elected to replace David Cameron in mid-July, has inherited the challenge of ensuring that the UK’s withdrawal from the EU occurs on the most favorable terms and with the least economic and institutional disruption possible.
Her party will undoubtedly incur the wrath of both supporters and opponents of Brexit if she is perceived to have botched the assignment, and both foreign and domestic political currents point to obstacles that increase the risk that her government will be judged to have at least partly failed when the process reaches its conclusion. However, with the opposition Labour Party enduring internal problems of its own, the Tories will have a substantial margin for error without endangering their claim to power, at least in the near term.
Both the Brexit vote and the more recent victory of Donald Trump in the US presidential election contributed to brief bouts of market volatility, but more generally the asset classes will take their cue from the signals coming out of the negotiations. The main uncertainty surrounds whether the EU is willing to accept a “soft” Brexit, under which the UK will concede a limited tightening of restrictions (for example, on trade in services) in return for greater freedom to control the flow of labor into the country, while otherwise enjoying access to the single market, or will instead press for a “hard Brexit,” which implies the erection of punitive barriers to imports of British goods and services more broadly.
In either case, businesses in some industries, such as financial services, will have an incentive to relocate their operations to the continent, while any export-oriented firms will have a disincentive to invest in their British assets until the broader terms of trade with the EU become clearer. That prospect points to a significant slowing of real GDP growth in 2017, when the uncertainty will be greatest.
The overwhelming majority won by the “Stay” camp in Scotland has raised expectations that the regional government headed by the SNP may push for another independence referendum. Support for remaining in the EU was also strong in Northern Ireland, where a fragile peace could be threatened if restrictions on the free movement of workers across the border with Ireland contributes to economic hardship.
On the positive side, the UK will enjoy freedom to conclude bilateral deals with key trade partners, including China, India, and the US. However, the willingness of the new administration in Washington to pursue FTAs is very unclear, and the UK will have less leverage negotiating on its own that it would as a member of the EU.