Today I focus on Brexit, including the implications for Nordic economies and markets. It is crunch time for the Brexit negotiations. The EU leaders’ meeting this week provided no breakthrough. Indeed, in Prime Minister Theresa May’s press conference on Friday, she chose a tough rhetoric, ruling out any kind of border between Ireland and Northern Ireland. The Conservative Party Conference begins next Sunday (and runs until 3 October), where Mrs May could be challenged by hardline Brexiteers. Then comes the EU summit on 18 October, which we, so far, have expected would be the ‘deal-making’ meeting. I now believe there will be an extra EU summit in November with the ambition to sign a deal. Finally, there is an EU summit scheduled for 13-14 December.
To recall, the EU and UK are currently negotiating the Withdrawal Agreement, which the parties have to agree on by end-2018 at the latest. This would ensure that the UK Parliament has enough time to vote on the draft agreement ahead of approval by the European Parliament (simple majority) and the European Council (qualified majority) before the UK officially leaves the EU on 29 March 2019. The trickiest part of the negotiations is the so-called ‘backstop solution’, which involves establishing a temporary solution for the UK’s customs arrangements with the EU if a new permanent deal is not ready in time, with the aim of avoiding a hard border between Ireland and Northern Ireland. The British government has suggested that the whole of the UK stays in the customs union for a while longer after the UK leaves the EU. However, the EU thinks that this is just a trade deal in disguise and wants an indefinite backstop. Instead, the EU has proposed that Northern Ireland effectively stays in the customs union until the parties have found a workable and permanent solution. However, Mrs. May has said she would not accept dividing the UK in such a way.
We judge that there is a 75% chance of a ‘decent’ Brexit, where the parties sign the Withdrawal Agreement. In this scenario, the UK would leave the Single Market but get an extensive free trade agreement with the EU. Firstly, both parties want to find a solution given the costs of a no-deal Brexit. Secondly, I believe the EU and the UK could find common ground in terms of limiting the number of goods entering Northern Ireland which would have to be checked at the border. We see a 15% risk of a cliff-edge Brexit, where the UK and EU do not reach an agreement. I believe there is only 2-3% probability of a new referendum before 29 March, while I see a 7-8% chance of a soft Brexit where the UK stays in the Single Market. In the ‘decent’ Brexit scenario, business would largely continue as usual for Nordic companies until end-2020 when the transition period ends. In a cliff-edge Brexit, the UK and the EU would have to trade under WTO (World Trade Organisation) rules. This would mean that trading of goods between the EU and the UK would be subject to customs checks and tariffs.
All the Nordic economies have a goods surplus but a services deficit with the UK. Among the Nordic countries, the UK is the relatively largest trading partner for Norway, while it is the smallest for Finland. However, to assess the impact of a cliff-edge Brexit it is important to look at the subgroups, as tariffs vary widely. In particular, Norway has a very large goods export to the UK but more than 80% of that is oil and natural gas, which face just 2.5% tariffs under WTO rules. Meanwhile, Sweden has a sizeable auto trade with the UK, which faces a 10% tariff under WTO. However, the total Swedish-UK auto trade amounts to 0.24% of Swedish GDP – a negligible number. Finally, Denmark has substantial agricultural exports to the UK, where tariffs vary between 15.5% for animal products to 35.9% for dairy products. A cliff-edge Brexit could have significant implications for specific industries of the Danish agriculture sector. However, Denmark’s agricultural exports to the UK still only account for 0.46% of the overall economy and a large part of the trade is likely to continue. Regarding services, I believe the UK would be more lenient towards the EU than the other way around in case of a cliff-edge Brexit. Still, I expect that both the EU and the UK would take a pragmatic approach in case of a no-deal Brexit while mitigating the immediate disruption in key areas such as transport, travel and business services. In sum, I see a cliff-edge Brexit as a modest risk for Nordic economies and markets, which is also how I expect central banks in the region view it.