By Darren Williams
Britain's divorce from the EU is under way, but the complex negotiating process has just begun. We believe a mutually beneficial deal can be reached - as long as both sides focus on the risks of failure.
The phony war is over. After Prime Minister Theresa May triggered Article 50 of the European Union (EU) Treaty, the clock is now ticking. Unless an extension is agreed, the UK will leave the EU in March 2019.
It's probably not worth getting too excited just yet, though. Dissolving the 44-year long economic and political relationship will be a thorny process. The immediate focus of negotiations will be on the terms of the divorce - particularly the controversial bill the UK needs to pay to settle its accounts with the EU. This is likely to take priority over the nature of the future trading relationship between the UK and the rest of the EU.
Short Window For A Complex Deal
Little substantive progress should be expected before Germany's parliamentary elections in September. This leaves only a short window to negotiate a complex trade deal, and why most informed observers think a transitional deal is likely.
The jury is still out on the terms of the future trading relationship. The UK will prioritize immigration and judicial sovereignty over access to the EU single market. And the EU has rightly stressed that the UK can't be allowed to cherry pick the bits of EU membership it likes, while discarding the rest.
Avoiding A Stand-Off
Negotiations may also be complicated by fundamentally different approaches to the talks. The UK is likely to take a commercial perspective while the rest of the EU will put political considerations to the fore. This different perspective helps explain the long-running tension between the UK and the rest of the EU and means the risks of a damaging breakdown are not slight.
If negotiations do sour, the UK clearly has most to lose. However, the rest of the EU would not escape unscathed, which is why we believe some form of compromise will be eventually be reached which avoids extensive economic damage.
The shape of any agreement won't become obvious any time soon. So markets are likely to return quickly to more pressing concerns. In the UK, the focus will be on whether rising inflation will trigger an early interest rate hike - we still think this is improbable.
For the rest of the EU, more immediate priorities include the outcome of France's presidential election, with Marine Le Pen's National Front party making a bid to put the far-right in power. The deteriorating political situation in Italy is an ongoing source of concern. And markets are starting to anticipate that the European Central Bank will taper its quantitative easing program earlier than they'd expected.
Ultimately, Brexit is just one of several political risks set to cloud Europe's economic and financial outlook for some time to come. And while these need to be carefully monitored, our base case is that none of them will crystallize and put at risk an economic recovery, which is now visibly moving on to a broader and firmer footing.