A Bad Brexit Deal May Be Better Than No Deal at All

The mantra within the British government as it prepares to hammer out the terms of its break-up with the European Union is that no deal is better than a bad deal.

Walking away with no regime for 230 billion pounds ($287 billion) of annual exports to the bloc and the 3.3 million Europeans in the U.K would be “perfectly OK,” says Foreign Secretary Boris Johnson. Not “frightening” at all, says Brexit czar David Davis.

But analysts are painting an entirely different picture of an outcome they view as increasingly plausible: U.K. Prime Minister Theresa May balking at the EU's demands or giving up on getting the sweeping trade accord she wants. And a collapse in the two-year talks, which May is set to trigger next week, would unleash costs and regulations that stand to damage Britain far more than the EU.

“A deal will take a lot more time, goodwill and tact than has been on display from either side,” said Anand Menon, director of The U.K. in a Changing Europe research group, who sees a 50% chance of there being no deal on March 29, 2019. “I find it very hard to see how May gets all she wants.”

An official in May's government puts the chance of the talk collapsing at about 30%. EU negotiator Michel Barnier this week said the bloc should ready to deal with the “serious consequences” of a breakdown, such as longer queues at borders to how to handle transportation of nuclear materials.

If May does walk away, then the U.K. would truly be in uncharted territory. Based on interviews and published analysis, here's a rough map of what might happen should Britain spin out of the EU without a safety net.

Even before May delivers an emergency statement to the House of Commons to explain the failure, financial markets would have already priced in the ramifications.

Jordan Rochester, a London-based strategist at Nomura International Plc, predicts the pound would slump towards $1.15, extending its post-referendum slump to almost a quarter. The day in 2013 when David Cameron announced his intention to call a referendum sterling was at $1.58.

Companies, meantime, would activate plans for the tumble over what they've long described as a “cliff edge” of uncertainty. Absent a deal, the U.K. would surrender tariff-free or friction-less trade with the EU's 440 million consumers and any hope of a transitional phase to adjust.

For manufacturers, World Trade Organization tariffs averaging about 5% — and twice that for cars produced by the likes of Ford Motor Co. — would be immediately imposed on trade with the EU, the market for 44% of Britain's overseas sales. Farmers could face duties of around 40% and most industries would suffer higher import costs if Britain imposed its own tariffs on trade from the EU.

That would reduce trade by about 30%, according to the National Institute of Economic and Social Research. Oxford Economics Ltd. estimates that by 2030, gross domestic product would be 3.9% smaller, or 96 billion pounds in inflation-adjusted terms.

At ports, border checks would impede commerce further; the likes of BAE Systems to J Sainsbury might struggle to get timely delivery from the continent to keep assembly lines humming and supermarket shelves stacked.

Then there's the City of London — a global hub of finance and the gateway for capital to and from Europe.

JPMorgan Chase & Co. and other banks that had hoped to keep servicing the bloc from London would likely accelerate the shift of jobs and operations into the EU or to New York. The consulting firm Oliver Wyman estimated that in a worst-case scenario, 70,000 financial-services jobs would be lost.

'Day One'

“On day one, JPMorgan has to be able to conduct business with our clients in Europe,” Chief Executive Officer Jamie Dimon told Bloomberg this month.

The French or Germans would, without delay, repatriate control of the clearing of euro derivatives, and credit-rating companies with bases in London would lose their authority to police continental companies. Xavier Rolet, CEO of London Stock Exchange Group, has said 232,000 jobs could eventually be lost from the U.K.

No deal would also further punish industries likely to be hamstrung by Brexit. Airlines such as EasyJet might see their access to the continent cut off unless they relocate headquarters or sell more shares to investors in the region to satisfy regulators. The hospitality and agriculture sectors already face a struggle to get the workers they need as do pharmaceutical firms like AstraZeneca, which would also have to deal with the loss of the European Medicines Agency from London.

The hardest of Brexits would also risk the imposition of a hard border between Northern Ireland and the Republic and embolden Scottish First Minister Nicola Sturgeon's push for a second independence referendum. This week's terrorist attack on London also underscored the importance of continental security relationships, which could be jeopardized.

For May, the threat to walk away is a basic negotiating tactic if the U.K. is to avoid being punished by the EU. “No deal for Britain is better than a bad deal for Britain,” she said in January, adding it would be an “act of calamitous self harm” for Europe to try to retaliate against the nation for its desire to leave.

May's bullishness reflects the bet that Britain's Blitz spirit would carry it through. She herself has held out the prospect of slashing corporate taxes to lure businesses and investment. Released of the EU's constraints, the U.K would also count on free-trade deals from China to the U.S.

If the talks do blow up, the most likely detonator is the demand that Britain must pay to leave. The EU's need to prevent other breakaway efforts requires a cost be imposed on Britain — a settling of accounts, in the view from Brussels.

“We have to calculate scientifically what the British commitments were and then the bill has to be paid,” European Commission President Jean-Claude Juncker told the BBC Friday. Asked if the bill will be 50 billion pounds, Juncker replied: “It's around that.”

U.K. Trade Secretary Liam Fox has described such a fee as “absurd.” Some in government have questioned its legality; the EU could force the issue before the International Court of Justice. Brexit campaigners back home would also balk at paying too much.

Money Talk

While May wants to discuss divorce and a new trade deal at the same time, EU officials say they won't even engage on commerce until the matter of the money is settled.

“The EU recognizes it has huge leverage and is ready to use it,” said Gregor Irwin, chief economist at Global Counsel, a consulting firm. “There is a risk of the negotiations unraveling because you're never quite sure how much it all means to the other side. If you push too far and it turns out they weren't bluffing, you end up with no deal.”

Even if a bill is paid, things don't get any easier. While willing to give up membership of the single market for goods and services to regain control of immigration and lawmaking, May wants to win as much trade free of tariffs and bureaucracy as she can.

That smacks of “cherry picking” to some in the region and if the EU balks, May could again walk. She will also know the risk of a poor trade deal would leave her prone to attack from the anti-Brexit lobby at home.

Talks might ultimately need to break down for progress to be made, according to Oliver Harvey, a strategist at Deutsche Bank AG. In that event, May would call an election aimed at winning a mandate to strike a deal some in her own ruling Conservative Party won't like.

“The U.K. will eventually compromise,” said Harvey. “But this will depend on a weakening economy and market pressure, with a full cliff-edge Brexit likely to be fully priced in at some point in the next two years.”

Bloomberg News

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