After winning yesterday’s British general election, Conservative Prime Minister Boris Johnson now faces an even more daunting task: he has until January 31, 2020 to move his plan to withdraw the U.K. from the European Union through parliament, which has been mired in an angry Brexit stalemate for nearly four years. Perhaps even more challenging, he then must negotiate a comprehensive free trade pact with the EU by the end of 2020, or risk triggering another major Brexit crisis over the economic dangers of leaving without a deal.

If trade negotiations don’t go well, Johnson has until June 30, 2020 to ask for an extension – something he has vowed never to do. With out a deal, the UK’s trading relationship with Europe, which currently consumes almost 45% of the country’s exports, would end. It would then have to seek new trade pacts (including with the EU). While a group of hard-Brexit proponents don’t want a deal in the first place, leaving without one is something most UK politicians want to avoid.  And this clash could trigger a heated debate and more economic uncertainty in the months ahead.  

Even though World Trade Organization rules would kick in if a deal can’t be reached, there are clear risks. Indeed, in response to long delays at the border and a loss of confidence in British financial institutions, the Bank of England believes the country’s economy might contract by 8% over a 12-month period. As well, the UK may have to pay £20 billion in unpaid bills to the EU.

There could also be negative economic fallout across the EU, with countries closest to the UK geographically expected to suffer the most. For one, Belgium is predicting that job losses could reach 42,000 if a deal can’t be reached. Additionally, Germany and France, which do large volumes of trade with the UK could be hard hit. For instance, the UK is the third largest trading partner for the German city of Bremen, and Berlin’s fifth largest.

Slowing growth, Brexit hurting Europe’s manufacturers

How likely is it that Johnson could avoid a hard Brexit by reaching a comprehensive trade pact with the EU in just a year?  For starters, hardline Tories want a deal allowing tariff- and quota-free trade, similar to those in the EU/Canada CETA agreement. However, that agreement took seven years to negotiate; suggesting that even if the EU was on board, Johnson would be unable to close a deal in 12 months. As a result, that likely means more economic uncertainty over the next year and beyond if the UK leaves the EU without deal.

The EU also has to uphold its own rules around trade to maintain regulatory integrity across the Eurozone. To that end, the EU’s chief Brexit negotiator, Michel Barnier, has warned that the UK could face barriers to trade if it diverged substantially from European trade laws, saying: “access to our markets will be proportional to the commitments taken to the common rules”.

Johnson, like his predecessor, Theresa May, signed a divorce agreement with the EU, under which the UK would leave the EU customs union. As part of that deal, in what has become known as the Irish backstop, Northern Ireland (which is part of the UK) would continue follow many EU trade rules.

However, for many Conservatives, fully breaking away from EU trade law is the entire point of the Brexit exercise in the first place. This leaves Johnson with little wiggle room in the months ahead. If he accepts a trade deal largely dictated by the EU, it could be strongly opposed by Brexit hardliners in his own party, who were instrumental in bringing him to power in the first place. But if he gives into their hard-break demands, Britain could leave without a deal – with negative economic consequences for both the UK and the Eurozone.

Underweight Europe in the Sun Life Granite Portfolios

The uncertainty around Brexit, and slowing global growth has been a major drag on the Eurozone economy. There has also been a sharp fall off in trade between a number of EU counties and China, including Germany, which is close to a recession. As well, the European Central Bank, which has lowered its key lending rate to -0.40%, has little ammunition left to boost the EU economy. As a result, we continue to be underweight European equities in the Sun Life Granite Portfolios until we see how Brexit ultimately plays out, and whether the Eurozone economy starts to improve.

This commentary contains information in summary form for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.

© Sun Life Global Investments (Canada) Inc., 2019. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.