By Matthew Elliott, Senior Political Adviser, Shore Capital

 

Anybody hoping that the world would enter a period of calm in global politics in 2018 is likely to be disappointed. The anti-Establishment backlash which surfaced in 2016 with the Brexit vote and the election of President Trump, and continued with strong performances for populist parties of both the right and left in the Dutch, French and German elections in 2017, is likely to continue to be a major factor in 2018. Across the West, voters are rallying to ‘change’ candidates and parties from both the right and left, leaving centrist ‘Third Way’ parties, which came to the fore in the 1990s and 2000s, struggling for relevance. Layered onto that uncertainty, of course, are on-going tensions with Russia, North Korea and Iran, so we are in for another eventful year politically.

Five key developments in the political world for business to follow in Q1 2018 are: Phase 2 of the Brexit negotiations; the tensions over the next EU multiannual financial framework (MFF); the Italian general election in March; the standoff between the EU and Poland; and the possible collapse of NAFTA. Each of these has the potential to cause major economic repercussions. 

 

1. Phase 2 of the Brexit negotiations

It was reported over the weekend that the Prime Minister is planning another major Brexit speech in mid-February, but before she makes that speech, the government will have to agree its game plan for Phase 2 of the negotiations.

The Cabinet is split into two camps. ‘Divergers’ (e.g. Boris Johnson and Michael Gove) wish to see the UK sign a comprehensive free-trade agreement with the EU but return full legal power to Parliament after Brexit (aka the ‘Canada plus’ approach). Whereas ‘Aligners’ (e.g. Philip Hammond and Amber Rudd) argue that the best approach economically is for the UK to mirror EU rules and regulations very closely, preserving the status quo to thegreatest extent possible as a non-EU member (aka the ‘EEA minus’ approach).

The Cabinet debate began before Christmas, once the European Council had given the greenlight for Phase 2, and the key phrase which seems to have emerged is ‘gradual divergence’, i.e. the UK will not be drastically changing its laws overnight when it finally leaves the EU, but will take back the power to do so in the longer term. The questions that will need to be resolved over the coming weeks include: Who will decide how gradual the divergence is? Who will decide how far the UK can diverge? Will the UK be able to make these decisions itself, or will it require complex renegotiations of the UK-EU trade deal?

Expect these questions to dominate the Brexit coverage over the coming months, both when they’re discussed by the Cabinet, and when the Phase 2 negotiations commence. They are integral to ensuring that the border between Northern Ireland and the Republic of Ireland remains frictionless post-Brexit. This aspect of the Phase 1 negotiations was only passed with a strong dose of ambiguity. The bar will be set far higher in Phase 2, so this issue will continue to be central to the Brexit negotiations.

Of less importance to the negotiations will be the issue of a second referendum. Brexit coverage continues to oscillate between substantial issues being discussed in Brussels between Michel Barnier and David Davis, and trivial issues triggered by statements from politicians who are commentators rather than actors in this process. There is no appetite amongst the public for a second referendum. As Brenda from Bristol might say, “You’re joking, not another one?”

 

2. Tensions over the next EU multiannual financial framework (MFF)

One key dynamic that will assist UK negotiators over the coming months is the continued tension between the remaining member states (the EU27) over the next multiannual financial framework (MFF) – the bloc’s roughly €1 trillion, seven-year fiscal blueprint, which runs to 2020.

In his State of the Union address in September 2017, Jean-Claude Juncker said the EU faced a choice: “either we pursue the European Union’s ambitions in the strict framework of the existing budget, or we increase the European Union’s budgetary capacity so that it might better reach its ambitions. I am for the second option.”

So in drawing up the budgetary plans it will present this coming May, the Commission not only needs to persuade the remaining member states to make up the shortfall from losing Britain’s net contribution of €9 billion or more per year, but also to provide additional resources for the EU.

The EU’s deadline for a draft MFF is May 2018, and the College of Commissioners discussed it at its first meeting of the year, on 10th January. With national elections coming up in Italy (4th March), Hungary (8th April), Sweden (9th September) and Ireland (November), it is a touchy subject that will get traction domestically.

 

3. The Italian general election in March

The first quarter of 2018 includes a number of significant elections. Finland goes to the polls on Sunday, 28th January and the first round of the Russian Presidential election will take place on Sunday, 18th March (with the second round on 8th April). In these elections, both the incumbents – President Niinistö and President Putin – are almost guaranteed to win.

Of more interest, therefore, is the Italian general election, which is set to take place on Sunday, 4th March. Since the New Year, three parties on the right – Silvio Berlusconi’s Forza Italia, the Northern League and the Brothers of Italy – have agreed to work together, making them favourites to form the next coalition government.

A recent Tecne poll put Berlusconi’s coalition at 39.2%, and a separate survey by IPR put it at 38% – putting it in good stead to reach the 40% threshold considered necessary to form a government coalition. The same polls give the left wing coalition, led by Italy’s ruling Democratic Party (PD), under the leadership of former Prime Minister Matteo Renzi, 20.7% and 22% respectively.

The 5Star Movement continues to be Italy’s most popular individual party in the polls – and will continue to dominate the headlines internationally – but it will struggle to form a government because it generally opposes forming a coalition with other parties. So 2018 might see the Lazarus-like return of Prime Minister Berlusconi, Europe’s answer to Donald Trump.

 

4. The standoff between the EU and Poland

Another headache for the European Union is its continued standoff with the Polish government. Shortly before Christmas, the Commission recommended the triggering of Article 7.1 of the EU treaty against Poland that would deem the country to be in violation of European values. Over the past two years, the Polish government has passed a number of laws that hand it the power to appoint judges – including those who rule on the validity of election results – thus challenging the independence of the judiciary.

At the European Council’s meeting in March, the member states will vote on the Commission’s proposal. To pass, it would require a super-majority of four-fifths, plus the support of the European Parliament.

In the meantime, Poland’s President has hit back, warning the EU against “stigmatising, dividing and antagonising” its member states. In a New Year’s speech, Andrzej Duda said the EU institutions should be serving the EU member states and not the other way around, and suggested that overreach by the Commission was also partly responsible for Brexit.

 

5. The possible collapse of NAFTA

Looking further afield, the negotiations to reform the NAFTA free-trade agreement rumble on. Officials will begin their penultimate round of negotiations in Montreal on 23rd January, but they are struggling to make progress, hampered by President Trump’s continued threats to withdraw.

In December, Mexico’s ambassador to the United States said that the agreement has a 50- 50 chance of being terminated, and Goldman Sachs predicts that withdrawal is the most likely scenario.

The first problem is what are perceived to be unrealistic demands from US negotiators, on automotive content rules, dispute settlement and a five-year sunset clause. The second issue is President Trump’s desire to use the negotiations to make good on his election promise that Mexico will pay for a border wall.

Mexico is an easy target for Trump, one that he targeted to great effect during his Presidential election campaign, playing on the concerns of people frustrated by American job losses, and overlooking the far bigger impact of China’s manufacturing boom. The US trade deficit with Mexico stood at roughly $63 billion in 2017, a fraction of America’s $347 billion trade gap with China. And with China’s debt having surpassed three times its gross domestic product, it is extremely vulnerable to financial shocks, which is an economic concern for 2018.

That said, with regards to NAFTA, President Trump prides himself on being the arch dealmaker, so a last minute reprieve for the trade deal should not be ruled out. Either way, with the world economy requiring more free trade rather than less, we should all hope that 2018 brings agreement on a UK-EU trade deal, the renewal of NAFTA, plus the launch of the Trans-Pacific Partnership (minus the US). 

Finally, it is worth sparing a thought for those in financial services who spent the run-up to Christmas preparing for the introduction of MiFID II, which took effect in the New Year. The new regulations from the EU weigh in at 7,000 pages, the equivalent of six Bibles, and many times longer than Dodd-Frank, the post-2008 financial regulations in the United States, which are a comparably slim 848 pages. I don’t imagine those City workers, burning the midnight oil, were amused when they learnt that BaFin, the German regulator, granted a request from Deutsche Börse, the owner of Eurex, the Frankfurt-based futures exchange, a further 30 months to enforce the rules. Eurex will only have to apply the rules from Friday, 3rd July 2020. Be sure to mark the date in your calendars.