deutsche-bank-polska2May at last provided the market some clarity on the UK government’s Brexit strategy. Key takeaways are summarized below, but PM’s careful avoidance of clear red lines on migration, the jurisdiction of EU law and EU budget contributions are positives, signaling needed flexibility in the government’s approach.

On the other hand, the comprehensive free trade agreement in goods and services that the UK seeks will require unanimous ratification by EU member states and is likely unachievable in the two year time period of negotiations under Article 50. It would also require significant goodwill among EU member states. In that sense, the next risk for markets will be the EU response, assuming A50 is triggered by end-March, particularly given the busy EU political calendar in H1.

On immigration. The speech struck a generally positive tone on the benefits of migration, particularly in skilled sectors. More importantly, May offered no red lines other than the UK regaining control of its borders and was very vague about details. Similarly, mentions of European law were kept to a minimum, while May also acknowledged the possibility of monetary contributions to EU programs (although not on the same scale as previously).

On trade. May made clear that the government strategy is for a ‘Canada-max’ style deal encompassing a comprehensive agreement on goods and services. This would leave the UK outside the customs union (CCP and common external tariff) and the Single Market, but with tariff free access and frictionless borders. This ‘have your cake and eat it’ approach runs counter to the consistent European line of ‘in or out’ and would require a considerable amount of political goodwill to achieve. It would also be very difficult to renegotiate within a two-year time frame (see below). Nevertheless, it was at least acknowledgement that the UK’s most important trading relationship would remain with the EU, while rhetoric over weaponising tax etc. was toned down.

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On process. One material piece of news was a parliamentary vote on the final deal. This is a moderate positive in the sense government will have to respond to MPs views throughout the process, but it is a matter for debate whether Westminster could ‘block Brexit’ as the question of Article 50 being irreversible has yet to be settled and would probably need to be referred to the ECJ.

On a transitional deal. May made explicit previous government rhetoric committing to a transitional deal, potentially encompassing immigration controls, the customs system, and regulation and budget contributions. The speech made it clear that the transitional deal would be an implementation period between an agreed deal and the future relationship but it will be extremely difficult to conclude and ratify a comprehensive new free trade deal in the time frame envisaged. It is not clear whether an agreement to conclude a free trade deal in the future (i.e. during the implementation phase) can be made part of the more limited exit agreement.

In terms of market implications, we see the speech as a moderately positive outcome relative to weekend headlines signaling a hawkish stance on immigration and relaxed attitude towards EU tariffs. Nevertheless, it is not a game changer. First, the decision to seek a bespoke deal combined with an interim agreement is a high risk strategy given the difficulty of reconciling the multiple competing interests of EU member states in agreeing to a new deal and assumes significant political goodwill. This is particularly the case over a very busy European political calendar during the first half of this year.

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