Salman Ahmed, Chief Investment Strategist

Different shades of Brexit and German elections

The much-awaited May speech on a Brexit roadmap in Florence was important as it narrowed down the different shades of Brexit on the table and reduced speculation around various scenarios, for example over whether there would even be an exit deal.

Up to this point, we think Britain had worked itself into a prisoner’s dilemma, where self-interest based narrow "rationality” was looking likely to lead to a sub-optimal Nash equilibrium from both Britain's and the EU's perspective.

However, Macron's spectacular victory in France earlier this year, Merkel's re-election in Germany, and the strong economic upswing in the Eurozone has strengthened the EU's negotiating hand. And looking to Germany specifically, the re-election of Angela Merkel for a fourth mandate as German Chancellor will also strengthen the country's position on Brexit, in our view. It is going to take weeks for the coalition to be finalised, but the most likely outcome will be a coalition composed of the CDU, the Greens and more importantly the FDP. Such a coalition could somewhat complicate Merkel's relationship with Macron on EU reforms, as the FDP rejects the idea of a common budget. As for the Brexit negotiation, the FDP rejects the idea that the UK could 'cherry-pick' what fundamental principles of the common market to keep.

Furthermore, it seems that the pressure of the "ticking clock” and dire warnings by businesses stuck in the uncertainty tunnel, amplified by a confused verdict delivered by the British public at May's recent electoral gamble has led to the UK blinking first in its challenge/game to find a post-EU future in Europe.

Game theory literature is rife with examples of how payoff set-ups can induce cooperation or conflict. It was always up to Britain to choose its Brexit path and improving EU realities have only narrowed the options in recent months, forcing cooperation over conflict.

On a positive note, we now have a significant reduction in the likelihood of a cliff-edge Brexit, with the Hammond school of thought in ascendancy over the backward-looking/anti- pragmatic vision of likes of Boris Johnson.

Charles St-Arnaud, Senior Investment Strategist

The price of cooperation will be a hefty divorce bill which will be agreed (most likely in incremental steps) in coming months, leading to a path towards putting on paper what the future economic relationship with EU will look like and what May will call a bespoke deal, not a replication of the Norwegian, Swiss or Canadian relationship.

As May iterated in her speech, Britain is not leaving Europe. If the agreed fees and penalties are paid, that would hold true and we think the latest rhetoric paves the way for a more amicable divorce than was thought likely, even a few weeks ago, especially with May openly saying that the UK will honour its commitments to the EU budget.

Looking ahead, we expect the reduction in the likelihood of a 'cliff-edge Brexit' to reduce to a certain extent. Industry/business concerns have also been somewhat assuaged by a clarification on citizens’ rights. We will see if a more cooperative equilibrium will be found and the next round of talks this week should provide an answer to this. Nevertheless, the main risk to the cooperative equilibrium to Brexit negotiations remains UK politics and depends on whether May manages to remain PM. Some hard Brexiteers may be sharpening their arms and waiting for the right moment to challenge May’s leadership.

 

important information.

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