Brexit Update

23 December 2016

Decline in industrial production…

Industrial production in the Eurozone declined for a second consecutive month in October. In comparison to September 2016, industrial production dipped with 0.1%. This was lower than the Reuters consensus forecast of a month-on-month increase of 0.2%. The decline in October was nonetheless smaller compared to September this year, when it fell 0.9% month-on-month. The year-on-year figure was a positive 0.6%, the third increase on an annual basis compared to July this year.

According to Eurostat, the October decline in industrial production, could largely be attributed to a lower production of non-durable consumer and intermediate goods. On the positive side, production of capital goods, such as machinery, and durable consumer goods, such as cars, rose by 1.0% and 1.5% respectively. These latter figures point to an underlying resilience even against the backdrop of uncertainty, after the UK referendum on leaving the EU and the US elections.

Industrial production in the Eurozone

Source: Reuters.

PMI Manufacturing index and industrial production index for the Eurozone

Source: Reuters. * Flash estimate.

… but manufacturing sub-index improved in December

The latest Purchase Manager Index (PMI) data for the month December and the Eurozone, showed a marked improvement in the manufacturing sub-index. In comparison to November this year, the Manufacturing PMI for December increased by  more than 2% to a value of 54.9. This is the highest level since April 2o11. A value higher than 50 indicates an expansion of activity. This rise may well indicate an improvement in industrial production in the coming months, as an increase in the PMI Manufacturing index tends to precede an increase in industrial production.

Further improvement

The latest PMI report was also encouraging in that, according to Markit - the compiler of the PMI data – manufacturing growth was supported by an increase in its components new orders, purchasing activity, as well as employment. These factors are indicative for a further improvement in near term activity.

The same report also indicated that service activity slowed somewhat, and that price pressures intensified. The latter partly as a result of rising energy prices and higher import costs, due to the decline of the value of the euro versus the US dollar. According to Markit the “average selling prices for goods and services rose at the steepest rate for nearly five-and-a-half years as firms passed higher costs on to customers”. This means that consumer expenditure may come under pressure in the coming months, as real income growth is slowed down by higher prices.

Politics

Last week the EU’s 27 leaders met informally without the UK to discuss their Brexit negotiation plans. The latest European Council summit in Brussels discussed migration, security, youth unemployment, Syria, as well as the Dutch reservations about the EU-Ukraine agreement, and Brexit was dealt with in the fringes of this meeting.

Before leaving the main part of the meeting however, the UK Prime Minister Theresa May made an overture to EU leaders with a request for an “early” deal on the rights of UK citizens living abroad and EU citizens living in the UK. The request elicited no formal response from the other leaders, but after the meeting some ministers gave a cautious welcome to the push for a quick deal on citizens’ rights, while stopping short of entering into negotiation without notification.

The meeting of the EU27 then went on to outline a negotiation process which would need to be based on a balance of rights and obligations, where access to the Single Market would require the acceptance of all four freedoms. It further outlined that the first step following the notification by the UK would be for the European Council to adopt framework guidelines for the negotiations under Article 50. The meeting stopped short of nominating the Commission chief negotiator for the EU, although it is widely expected that the Commission will lead the talks on behalf of the EU. In the current wording the Council “will be invited to nominate the European Commission as the Union negotiator”, and “the Commission's nomination of Michel Barnier as chief negotiator is welcome”. After a spat with the European Parliament earlier in the week, which nearly saw the EU’s united façade crackle, the conclusions also offered a compromise to Parliament, allowing them to attend preparatory meetings. Thus far, the EU is showing remarkable unity in one of the most complex issues facing the institution.

On the UK side, some incremental moves in the government’s position are worth noting. The UK’s Brexit negotiator David Davis now believes that a transitional deal would be a possibility, after refusing the idea last month. Given that many, including the UK’s ambassador to the EU, think a post-Brexit UK-EU trade deal might take 10 years to finalise, any interim deal would be essential to reduce uncertainty for business. On the other hand, minister Davies also announced that the UK will not negotiate with the EU over immigration. If the EU continues to stand firm on the inseparability of the four freedoms the stance of the UK and that of the EU, may  seem hard to reconcile. In terms of timing, the UK government has said it would only reveal any negotiating plan in February 2017 at the earliest, possibly wanting to avoid a debate in the UK Parliament, in the case that the Supreme Court would uphold the demand for Parliament to vote on the triggering of Article 50. While all analysts expects such a vote to pass, ministers would want to minimize the amount of amendments UK MPs could make to the bill.

On the business side, a large UK bank has put a timetable on plans to move part of its operations to the EU. It is choosing a destination from a shortlist of five and is likely to decide on a proposal by February next year. Meanwhile some Japanese financial institutions have asked for clarity on the UK’s future relationship with the EU, otherwise threatening to begin moving some functions from London within six months.

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Jan Willem Velthuijsen
Chief economist PwC
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