Political events are likely to cause concern to business in early-2018

Political events are likely to cause concern to business in early-2018

Anybody hoping that the world would enter a period of calm in global politics in 2018 is likely to be disappointed.

The anti-establishment backlash that surfaced in 2016 with the Brexit vote and the election of President Trump, and continued with strong performances for populist parties of both the right and left in the Dutch, French and German elections in 2017, is likely to continue to be a major factor in 2018. Across the West, voters are rallying to 'change' candidates and parties from both the right and left, leaving centrist 'Third Way' parties, which came to the fore in the 1990s and 2000s, struggling for relevance.

Layered onto that uncertainty are ongoing tensions with Russia, North Korea and Iran, so we're in for another eventful year politically.

We see five key developments in the political world for business to follow in the first quarter of 2018. Each of them has the potential to cause major economic repercussions.

  • Phase two of the Brexit negotiations

Over the weekend, it was reported that the UK Prime Minister is planning another major Brexit speech in mid-February. Before she makes that speech, the Government will have to agree its game plan for phase two of the negotiations.

The UK Cabinet is split into two camps. 'Divergers' (eg Boris Johnson and Michael Gove) wish to see the country sign a comprehensive free-trade agreement with the EU but return full legal power to Parliament after Brexit (aka the 'Canada plus' approach). 'Aligners' (eg Philip Hammond and Amber Rudd) argue that the best approach economically is for the UK to mirror EU rules and regulations very closely, preserving the status quo to the greatest extent possible as a non-EU member (aka the 'EEA minus' approach).

The Cabinet debate began before Christmas, once the European Council had given the green light for phase two. The key phrase that seems to have emerged is 'gradual divergence', i.e. the UK will not be drastically changing its laws overnight when it finally leaves the EU, but will take back the power to do so in the longer term.

The questions that will need to be resolved over the coming weeks include:

  • Who will decide how gradual the divergence is?
  • Who will decide how far the UK can diverge?
  • Will the UK be able to make these decisions itself?
  • Or, will it require complex renegotiations of the UK-EU trade deal?

Expect these questions to dominate the Brexit coverage over the coming months, both when they're discussed by the Cabinet, and when the phase two negotiations commence. They are integral to ensuring that the border between Northern Ireland and the Republic of Ireland remains frictionless post-Brexit. This aspect of the phase one negotiations was only passed with a strong dose of ambiguity. The bar will be set far higher in phase two, so this issue will continue to be central to the Brexit negotiations.

Of less importance to the negotiations will be the issue of a second referendum. Brexit coverage continues to oscillate between substantial issues being discussed in Brussels between Michel Barnier and David Davis, and trivial issues triggered by statements from politicians who are commentators rather than actors in this process. There is no appetite amongst the public for a second referendum. As Brenda from Bristol might say: "You're joking? Not another one?"

  • Tensions over the next EU multi-annual financial framework

One key dynamic that will assist UK negotiators over the coming months is the continued tension between the remaining member states (the EU27) over the next multi-annual financial framework (MFF) – the bloc's roughly EUR1trn (US$1.22trn), seven-year fiscal blueprint, which runs to 2020.

In his State of the Union address in September, President of the European Commission Jean-Claude Juncker said the EU faces a choice: "Either we pursue the EU's ambitions in the strict framework of the existing budget, or we increase the EU's budgetary capacity so that it might better reach its ambitions. I am for the second option."

In drawing up the budgetary plans it will present this coming May, then, the Commission not only needs to persuade the remaining member states to make up the shortfall from losing Britain's net contribution of EUR9bn or more per year, but also to provide additional resources for the EU.

The EU's deadline for a draft MFF is May this year, and the College of Commissioners discussed it at its first meeting of the year, on 10 January. With national elections coming up in Italy (4 March), Hungary (8 April), Sweden (9 September) and Ireland (November), it is a touchy subject that will get traction domestically.

  • The Italian General Election

The first quarter of 2018 includes a number of significant elections. Finland goes to the polls on 28 January, while the first round of the Russian Presidential election will take place on 18 March (with the second round on 8 April).

In these elections, both the incumbents – President Niinistö and President Putin – are almost guaranteed to win.

Of more interest is the Italian general election, which is set to take place on 4 March. Since the New Year, three parties on the right - Silvio Berlusconi's Forza Italia, the Northern League and the Brothers of Italy - have agreed to work together, making them favourites to form the next Coalition Government. A recent poll put Berlusconi's coalition at 39.2%, while a separate survey came in at 38% - putting it in good stead to reach the 40% threshold considered necessary to form a government coalition. The same polls give the left-wing coalition, led by Italy's ruling Democratic Party (PD) under the leadership of former Prime Minister Matteo Renzi, 20.7% and 22% respectively.

The 5Star Movement continues to be Italy's most popular individual party in the polls - and will continue to dominate the headlines internationally - but it will struggle to form a government because it generally opposes forming a coalition with other parties.

There is every possibility, then, that 2018 might see the Lazarus-like return of Prime Minister Berlusconi, Europe's answer to Donald Trump.

  • The stand-off between the EU and Poland

Another headache for the European Union is its continued stand-off with the Polish Government. Shortly before Christmas, the Commission recommended the triggering of Article 7.1 of the EU treaty against Poland that would deem the country to be in violation of European values. Over the past two years, the Polish Government has passed a number of laws that hand it the power to appoint judges - including those who rule on the validity of election results - thus challenging the independence of the judiciary.

At the European Council's meeting in March, the member states will vote on the Commission's proposal. To pass, it would require a super-majority of four-fifths, plus the support of the European Parliament.

In the meantime, Poland's President has hit back, warning the EU against "stigmatising, dividing and antagonising" its member states. In a New Year speech, Andrzej Duda said the EU institutions should be serving the EU member states and not the other way around, and suggested that overreach by the Commission was also partly responsible for Brexit.

  • The possible collapse of NAFTA

Looking further afield, the negotiations to reform the North American Free Trade Agreement rumble on. Officials will begin their penultimate round of negotiations in Montreal on 23 January, but they are struggling to make progress, hampered by President Trump's continued threats to withdraw.

In December, Mexico's ambassador to the US said that the agreement has a 50% chance of being terminated. Goldman Sachs predicts that withdrawal is the most-likely scenario.

The first problem is the demands that are perceived to be unrealistic from US negotiators on automotive content rules, dispute settlement and a five-year sunset clause. The second issue is President Trump's desire to use the negotiations to make good on his election promise that Mexico will pay for a border wall.

Mexico is an easy target for Trump, one that he targeted to great effect during his Presidential election campaign, playing on the concerns of people frustrated by American job losses - and overlooking the far bigger impact of China's manufacturing boom. In 2017, the US trade deficit with Mexico stood at roughly US$63bn, a fraction of America's $347bn trade gap with China. And, with China's debt having surpassed three times its gross domestic product, it is extremely vulnerable to financial shocks, which is an economic concern for 2018.

That said, with regards to NAFTA, President Trump prides himself on being the arch dealmaker, so a last-minute reprieve for the trade deal should not be ruled out.

Either way, with the world economy requiring more free trade rather than less, we should all hope that 2018 brings agreement on a UK-EU trade deal, the renewal of NAFTA, plus the launch of the Trans-Pacific Partnership (minus the US).

Matthew Elliott is a senior political advisor at investment advisor Shore Capital Markets.