« Exchanges at Goldman Sachs

Defining the Terms of Brexit

2016-11-14

As the UK moves closer to triggering formal talks on its exit from the European Union, investors are focused on the terms of the new relationship it will strike with Brussels. Goldman Sachs' Chief European Economist Huw Pill discusses the spectrum of issues to be resolved in the negotiations and what the ultimate outcome between a "hard" or "soft" Brexit means for the UK, Europe and the global economy.

This podcast was recorded on November 8, 2016.

All price references and market forecasts correspond to the date of this recording.

This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this podcast does not constitute research or a recommendation from any Goldman Sachs entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs, and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs to that listener, nor to constitute such person a client of any Goldman Sachs entity.

Copyright 2016 Goldman Sachs. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanges of Goldman Sachs, where people from our firm shed their inside Son developments currently shaping markets. Industries in the global economy, objects, Ewart, Global, have corporate communications here at the firm. It's been four months since the said, vote stun global markets, and while we now have some clarity about what to expect and when to expect, it plenty and certainly remains, I'm joined today by Hugh pill. Goldman Sachs, his chief european economist,. Discuss the latest developments how negotiations might play out and the implications for central bank. Policies and growth who welcome the problem. Thank you very much Your last on the programme of June there's been a lot of talk since then about how breaks it will take shape with what's been called a hard breaks. It looking more likely, there's no wonder condition of that. What does it mean to you, hard breaks? It won't work Last year we talked about the vote being votes
certainly in the love respects so, this clearly rejection of the status quo, but it wasn't really a vote for anything specific and though I knew that no new the pass. No one knew what breaks it made the news Minister, MRS May, her original formulation was breaks. It means breakfast which borders some time, but probably didn't really, five the issue by nature, So I think the debate has become a little bit polarized between the idea. We have a soft breaks it, which perhaps means Essentially the? U K, may institutionally leave some of the machinery of the EU so formerly is outside the EU, but then ass. It remains de facto apart of things like the single market for goods and services. And as a result, it has a status, perhaps so It's not that which Norway has in the European economic area, where it's not fully, and crucially a part of the EU, but in lots of economic and financial respects its effectively part of the EU. So, let's go
the usual definition of soft drugs. Then at the other extreme, and I think it's pretty easier to characterize the two extremes than is the intermediate states, the other kind of extreme version of a hard breaks it or the heart storm of breaks. It would be for the UK to walk away from the institutions of the EU. By nature reverts to walk trees, which out don't have said agreements I would the EU, or by the EU with third countries what their relationships in the international economic sphere. So kind of reverting to the W P. O rules betrayed, for example, nothin If that's the definition of hard breaks it it's a very unlikely outcome of this whole process, just to draconian to draconian too costly. Equally, if the definition I gave a soft brakes. If I think that's an unlikely outcome, learns can't really allow that, otherwise, you have everyone,
I think that most of the exits- and I think, also is probably not politically feasible in the UK to essentially say- were giving up having an influence over the rules through the institutions of the EU and yet was still going to abide by the rules to retained access into the single market and so forth, so This debate about hard versus soft breaks it if you characterized as the to kind of polar extremes, it's a little misleading because the reality is would probably almost never going to end up somewhere between those. So it's not behind. This warm it's, not the softest for it somewhere. Between and an that's probably the nature of the negotiations. We're gonna see over the next few years, wearing that Spain, so we going to end up I think we ve learned over the last few months. I think financial markets and observers have come to recognise. Is that It may be not so easy to see. This is a very continuous spectrum of possibilities. Wakened just pick out where you want to be the prime.
This has said in her speech. The conservative party conference, that she really has two key objectives she wants to have in place the first age she won't do. He asserts control over migration into the UK, both my girl. In from outside the EU, but also regulation from inside the EU. Put that back into british control. Second, she said: is she doesn't want the european growth she do that unilaterally? that's something that is very hard to reconcile with continue membership of or participation in the single market? the european side, so the residual you, the twenty seven countries on the other side of the negotiating table. I think Our position is The EU is based around the assertion of the famous for freedoms, the free movement of goods, the free movement of people, the free movement of capital, the freeway, of services, adding one characterisation of what MRS May is trying to us. What is will we
like three of those freedoms but will control divided, will will control the people exactly. We will have the will have no freedom of people. I think That is something that is unacceptable to the rest of Europe. Partly because the whole sat up of the EU is based on the indivisibility of these four freedoms. And second related, as you said, if you allow Some cherry picking will have three, but not the fourth. Was we don't like the fourth? you inviting every member of the EU to say we will have this combination, but not the ones we don't like, and the whole structure will then begin to break down the that is all based upon a set of compromises and some given take if you and I we country just to take what it wants but not gave what it needs to give in order to achieve that, I think it just becomes a workable system, What point do the voters who voted for breaks it get a little FED up that there's been no movement on migration and securing the Uk Borders politics
is a business which has an economist is sometimes seems like a strange business. I don't people in the UK are expecting this to be delivered overnight. I dont think that too parents would delay, is infinite. However, and I think one of them reasons why MRS May has a number of deadlines, notably the deadline that she intends to invoke this famous article. Fifty of the treaty, which the mechanism triggering the negotiations for exiting the EU. She intends to trigger the process by the end of March next year, To reassure the majority. People who votes in the referenda that we're on our way forward and second I'd say is that I think this is important to keep in mind even though Missus by herself was on the remaining size, the governor, has embraced the view that the british people have spoken and their interpretation of what it means the british people have spoken is essentially these,
first things. First, institutionally, you need separation from the EU. Second, they must reassertion of control over migration. Third, the ability of the European Court of Justice so that Luxembourg based Europe institution Supreme Court of Europe. If you like, it's you, Fiction over the UK has to be replaced by british courts, are learning she moves forward on those dimensions, are not unreasonable conclusions to draw after a vote to leave the EU exactly so many hard to engineer it right. The way I would say it is the failure to deliver on those dimensions, maybe by the end of March next year, but to set up a framework which is They acted on through the middle of next year, which respects So the three key creating positions. Failing to do. That will be very politically challenging for MRS May, both within her. Partly because there's a strong euro
take wing within the conservative party, which, if she fails deliver on those dimensions? I think we'll see here as not accepting another referendum, but perhaps more fortunately a more widely She will run into a broader political challenges, so the domestic political imperative, both broadly from a party point of view is that may has to deliver on those types of things. Runs into the position taken by but on the other side of the negotiating table, the EU twenty seven, whose will once you're moving down the path to achieve those things, then soft breaks it basically doesnt work and so on. You start to move down the spectrum from going from soft breaks. It were effectively stay inside the single market, but you give up some institutional, if you're, not accepting the jurisdiction of the European Court All those regulations
harmonization of regulation and business standards in competition law and so forth, which is what makes the single market work there's. No one too was that no one to judge that, so you essentially putting yourself outside the single market once you insist that you're not gonna, subject yourself to the European Court of Justice once you're out, the single market. I think people ten, think maybe you can get close, but without this oversight from the European I think, that's very difficult to do, because once you out the single market. What's the next April can stay within the Customs Union, some people say stems union means that Britain can have free trade with the rest of Europe. Crucially in the Customs Union. The oppian institutions will agree the trader it was so called third countries with China, with the U S with Canada and so forth, and Britain has to accept what that trade negotiation is now runs a loaded to what they think they voted for exactly
more you have a whole new department of government in the UK which MRS may set up, which is specifically designed to sign trade agreements with third countries, so it doesn't seem likely that that's a natural stopping point, So where are you beyond that? Will you could have a free trade agreement between the K in the EU Free trade agreements, sounds quite close. The single market's right, you still able to trade without tariffs, but in practice it's not that close the single market first, because Free trade agreement typically only involves trading goods, not trade in services and obviously for the Uk Business in financial services, a very important part of its economy in a very important part of its trading relationships seconds. You're? Having a free trade agreement, obviously, as a danger from the european point of view that an american company could export something to the UK re exported in the EU to avoid any tariff that the Eu Labour market goods searching.
Into a free trade area agreement that you have I'm so. Restrictions on what the local content to export they have to be based on the very thorny issue. Particular trade negotiation raised is for sure, and it means the Everything that export aid has to be checked there's, a whole bureaucratic process so free trade in that context is not that for and certainly nowhere near as free as the current single market arrangement means you, you're able just the same goods across borders within Europe, really with very little bureaucratic intervention. And then finally, just to amplify what I said a moment ago about the nature regulation so forth. The whole point the single market has being to create harmonised set of regulations and so forth, such that on it today basis firms don't have to worry about exporting something rolls Royce can make the same engine for an aircraft in the UK is accounted for and it meets all the same environmental regulations and so forth, and so on. What
outside the you you're not subject to the same european cultures, either. You just have to follow them anyway, which is a very difficult thing to do if your vote was to be outside european sphere, but the moment you introduce a new set of regulations, you gonna end up in the nobility outright pretty Sir Simon, The thing is: when we have this debate: harvest hisself breaks it. There are those who think It can be very soft, I'm not sure that's politically feasible or economically feasible. Equally, I think the it is very hard for just walking away reverting to allude to rules that are seem very likely either the most. Likely outcome of this is. We can have a long drawn out process where we try and find an acceptable point to both sides in the space in between probably not gonna be a soft, as many people may have thought in the past, is the vote. The ECB like data coming out of. You has actually been not bad and somewhat surprising. The sterling has declined sharply as as one might expect, but the girl rates have been a little bit better than expected. Sinfully vote has that shit
your view and the likelihood of recession in the UK even immediately the referendum we had us the formulation that Britain would flirt recession and silly, we didn't anticipate a steep downturn in the economy akin to what we ve seen leave or in the early nineties, eighties or the only nineteen nineties. Our view was that the UN's anti generated by the hour the referendum and the uncertainty about what that would lead to, which is reflected in what we just been discussing That would weigh on some investment projects and on our analysis. This is shared by the Bank of England, and other official forecast is. Is the are still reasons for concern on that dimension. Pound devalues gonna, see some inflationary pressure which may give the monetary authorities a little bit less wriggle room. I think that's true
so eating into the real value of in camels and therefore, probably at some point begin to dampen consumption and spending going forward. But I think the slowdown in investment that we are anticipating we, really see any evidence that that isn't happening. We never it was gonna, be dramatic. Why don't we do it, to see in our current forecasts, still a slowdown in the UK economy next year, but the consumer and the sort of Detail and service is part of the economy less immediately vulnerable to these uncertainty effects. Not only has stayed relatively robust as we expected, but if anything it's tended to be boosted and perform more strongly. We expected so yes, the Kay economy has surprised us website the upside, and I think many others probably the underlying story on the kind of investment side. We haven't really seen reason I'll, try out over the slower burn. I think that's right and it's been a little bit, shall we say obscured by the fact that the house
back to the retail sector, not is maintained its momentum, but has actually begun a little bit to accelerate how persistent that is in the seven underlying slow down the economy next year, I think, remains to be seen, but I think still reasons to expect that the economy was slow in the first half of next year will be, it to where we were three or four months ago, slow down now is still compatible with reasonably by European States reasonably steady pace of positive growth, the risk of a recession moving into native territory and seeing a contractual the economy having diminished quite a lot. So, let's go This is about the labour market have been given. In fact, I think our hard breaks it or one of the harder breaks it scenarios and violation that we are seeing incipient signs of a beginning, but that have on unemployment in the UK. In our view, is that will slow down the economy but a slow down that keeps us away from recession and largely
acting necessary adjustments to the new world. We live in an approach wrecks of environment one of the good things about the UK? Is that through the efforts of the in thirty is there is a lot of flexibility, in the economy in general, and perhaps relative to european, particularly relative to the continent grasses, and particularly in that context, on the labour market dimension, so the abyss, the key of the UK economy to a jest with, perhaps not seeing to signal, can rises in employment. Aren't you probably relatively high. So we Don't expect to see unemployment. We move back towards much higher levels that we ve seen in the early. Teenagers and only nineteen countries in the UK indeed Even in the adventurers very deep recession we had in the U K posts Lehman unemployment not rise in life, with a sort of historical relationship with economic activity and employment creation remained relatively. Strong brood
secondary period. We don't really see any reason for that to change structure. The UK has become Call me: that's better able to manage these adjustments and, through the technical swings without seeing big fluctuations in employment Once more. I think policy make us in general and frankly, the Bank of England in particular, has made quite a lot of play of the fact that its policy orientation is designed to avoid the loss of jobs to support the labour. So there are those critics of the current one these of central banks in general, including in the other thing. We have the same debate and states that the twin goals and aggressive, but critics who say you know negative rates. Q II and the count consists acuity on yields in the flat YE ll kill them waiting. Savers and, I think the leading. Hills at the Bank of England have been quite explore vision, saying in the current context, if it's a choice about hurting
savers temporarily in order to preserve jobs. And avoid that we generate all the long term, unemployment and kind of dislocations their pushing people into unemployment causes. Batter too those temporary cos. On savers in order to support the economy and particularly to support job creation, the economy raw the Van taking risks with unemployment, conclusions. Here his kid. The slowdown in the economy. The UK is structurally and position to try me It is true that, without generating high levels of unemployment or high levels of unemployment, now I think not is that true in terms of the structures in the economy, I think policymakers are prepared to quite aggressively use them all ethical, smoothing tools to achieve unemployment losses, even if that comes at the cost of others. Now, let's talk about the European it's more broadly live held up pretty well in the wake of the blacks vote. Do you see that come
some see or cautious optimism prevailing as we move forward we'd characterize the bricks it shot with? The benefit of hindsight is its law Juliet idiosyncratic and still an adverse shock to the Uk- that has been accommodated, at least the spa through quite a bit movement in sterling, as you mentioned, which has complacently consequences, another negative effects, but the fire mobility. The UK exchange rate has proved. Important shock absorber to begin to make the necessary adjustments to the new world, but the spillovers into the other parts of you're, a continental Europe and indeed to the broader world economy. Both again financially have been relatively modest and in some but good reason, relatively modest. The UK is just not a big part of the world economy or even ultimately a big enough mark if the european economy to have severe disruption, the risk
was which I think we pointed to ahead of the referendum. If breaks, it is seen as a sort of institution you know, breakdown or catalyst. For an institutional breakdown in Europe, european governance. You governance, particular Euro area governance has proved quite we in the past markets of challenge in the sovereign and banking crisis we saw five years ago. Some efforts have been made to improve that got a number of new institutions: the Banking Union, the o empty of the easy, be other backstop essentially to try and improve this. Those haven't been developed they haven't been fully tested. This could be, challenge. If those had failed, we could have seen a big contagion. The good news is that we have and seeing a big challenge, or at least those back stops, approve sufficiently robust to get us through, and I think that's fighting the fact that european markets move we have not dramatically changed in the face of exit, but that's, I think,
Tat is not necessarily showing the european markets in a robust be healthy condition Williston. By that I mean the european growth is tepid, as it seems to bid for a very long time now, which suggests a role for continued monetary policy, but at the same time, the costs in the side effects of queuing politically. This negative interest rates have come in focusing urban where's. They ve moved on more more unusual extraordinary measures to what extent policymakers, worried about counterproductive impacts of monetary policy induce your role for fiscal policy forward. Is it possible? Europe? Doesn't have a central fiscal policy, but could policymakers, push a little bit harder on fiscal time. Yes, there is, soon. I'm quite broad based concern that monetary policy is running into buffer I think there is a general concern that the effectiveness of monetary policy in terms of
providing easier conditions and stimulation economy is running into the sand. In Europe we have a very bank scented financial system, that's different from say here in the: U S! So when we, cut rights to the extent that. Pressure on banks, earnings, because your squeezing the margins of banks and so forth that me that may be. Banks are less to lend them they might otherwise be it is their transmission mechanism is beginning to break it. Breaks to such an extent your brain through banks, which you have to do in Europe, because the overwhelming be the largest part of the financial sector. This is he's into perhaps view with some caution: the ability of monetary policy to do more and additional concern, which is not that just monetary policy isn't working. It's that attempts to ease monetary policy she having counterproductive effects. I think that's a concern which is particularly acute in what we used to call CORE Europe: Northern Europe, Germany and the Netherlands, where
the combination of negative rates and very significant cutie sovereign asset purchases. He's not only creating a low yielding, while also on whether yield curve is very flat and financially solutions that rely on to improve so slope of veal curve to make money or finance. Institutions like pension funds that have defined benefit liabilities that promising to pay a one percent return, and yet assets which maybe only a negative returned. The best model that these institutions is under. Let's put it the significant stress in this modern day, Europe Data banks by larger in very difficult using low single digit, returns on capital. So conclusion is the scope for monetary policy to do more is limited, and in some parts of Europe at least attempts to do may not just have no effect that may have a negative effect. Something
actual in that context, to look to fiscal policy to pick up the button and provide a greater amount of stimulus. Frankly forecast the only reason the Euro area is growing above trend. So wishing eating into the slack in the economy any forces to bring unemployment, any fault is to reduce the domestic disinflation. Repression is because their support Please, and going on that Fiscal easing is caused by a variety of factors. In the short term, the need to hey for feeding, clothing and housing. The refugees that came to Germany last year, additional stimulus, rather the fact that security in Durban spending is going up in the aftermath of the terrorist attacks in France and Belgium, also unintentional cinemas and the family.
Elections in all the big five Euro area countries, usually good for stimulus, is usually get faster. Ministers of those are not perhaps the best reasons, but they are leading to an easier fiscal policy which is sustaining demand allowing this about trend growth crucially clearly in the heavily indebted high deficit, low fiscal credibility. An old latin european countries. Their ability to sustain this fiscal easing to have this train growth rests very heavily on the fact that that ability to issue in markets at low rates is under written by the fact the easy B is active in those markets present in those markets. Virus sovereign asset purchases Curie Programme, so that the sense though Europe is working right it's what the union is working as it is working in the sense that we are avoiding a big disaster. It's not in the sense that were finding a solution to deeper problem now, but
The credibility inherent in the institutions is translating into by weaker parts of. I think that's right, but I think it also makes the point by your question about monetary policy is diminishing: ineffectualness fiscal policies, take up more the role. The truth in that, for the reasons I think I said it's also true, though the distinction between motion fiscal policy is to some extent blurring here. So the billowy of fiscal policy. In these heavily indebted high fiscal deficit, low fiscal credibility, countries to ease fiscal policy, is dependent on the fact that the centre, is buying their debt, which is often rice curious a monetary policy operation, but here it has important fiscal implications as well. Our view is, there is a lot of scope for a lot of expectation for fiscal policy later this month, the chancellor, Mr Herman's will make his autumn statement in parliament this week,
the statement of the spending plans for next year- and we expect him to announce some easing of fiscal policy, there's a debate about how much he needs to do, given that the economy is holding it better than many people have anticipated. Theirs debate about how much room he has because tax receipts have we and in the autumn of abreks it maybe not because it breaks it- our eggs station, though, is that he will deliver quite a significant set of supportive stimulus, measures largely in the form of increased infrastructure, public infrastructure spending, not necessarily on big headlines projects, although there are a number of bigger headline projects in the works, but more generally and sort of supporting school contraction, road construction and improvements and so forth anticipate that too, About half a percentage point to growth in the economy, other things equal over the next couple of years, I think, that's quite a significant easing of this that is being facilitated by the fact that
the new government. Mr haven't new chancellor, have decided to abandon some of them. School rules that his predecessor, Mr Osborne, the preceding government had put in place to ring the Uk Biological, thereby into balance by the end of this parliament. So, by the end of this decade, effectively, we Looking to Mr Hamon to introduce a new set of rules, think he will try and operate completely outside a formal framework of rules Those rules are almost certainly going to be less onerous, less restrictive and that's opened up some space for him to do. Provided which is expected. Provided that financial market, some particularly international investors, contain to have confidence in the macro economic policy framework in the UK in the fundamental sustainability of the UK public finances in the credibility of the Bank of England inflation target which will cap the potential for me
in costs of the government to rise very significantly, you thank you. Much for joining us today. Thank you. That concludes this episode of extra Goldman Sachs, I'm Jake see where we hope you join us again next time this box, ass was recorded on November eight, two thousand, sixty all price references and market forecasts correspond to the date of this recording. This podcast should not be copied, distributed, published or reproduced in whole or in part. The information contained in Spock ass does not constitute research or recommendation from any Goldman Sachs Entity to the listener. Neither governments
nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any liability. Therefore, including in respect of direct indirect or consequential loss or damage, is expressly disclaimed, the views expressed in this podcast or not necessarily those of Goldman Sachs and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs too. That listener, nor to constitute such person. A client of any Goldman Sachs Entity
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