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10 months ago
European Union to take hard line with UK in divorce proceedings
October 13, 2016 / 1:18 PM / 10 months ago

European Union to take hard line with UK in divorce proceedings

A European Union flag is waved over a statue of former Prime Minister Winston Churchill as demonstrators protest during a "March for Europe" against the Brexit vote result earlier in the year, in London, Britain, September 3, 2016.Luke MacGregor

LONDON (Reuters) - The European Union will take a hard line during the two-year divorce negotiations with Britain, a Reuters poll of economists found, while a crash in the value of the pound is set to push inflation above the Bank of England's target next year.

Concern about how much inflation might rise has split economists' views on interest rates. Twenty-seven of 53 respondents in the poll predict a cut in Bank rate in the fourth quarter, with 22 of them saying it will be by 15 basis points.

Twenty-six saw no move this year.

A majority of Britons voted on June 23 to leave the economic and political bloc. Prime Minister Theresa May has said she will trigger Article 50, which starts the two-year countdown to divorce from the EU, before the end of March.

Many now suspect May is leaning towards a "hard Brexit" -- meaning giving up trying to remain in the EU's single market in order to impose controls on immigration. Such a move could hinder trade, particularly in services, and hurt foreign investment.

"Under these circumstances, the EU is likely to adopt a hard stance in order to remind the UK, and indeed other EU members, that it has to sign up to free movement of labour if it wants access to the single market," said Peter Dixon at Commerzbank.

All but one of the 27 economists polled in the past week who answered an additional question said they expected the EU to take a hard or very hard line with Britain.

When asked to recommend what attitude the EU should adopt they were a bit more divided, with two-thirds saying it should be a hard or very hard line in the negotiations.

This same panel of economists covering the UK were nearly unanimous in the run-up to the referendum in warning a vote to leave the EU would damage the economy, and correctly predicted it would trigger a sharp fall in sterling.

While they now say the chances of a technical recession are about one-in-four, that initial call was for a very shallow recession, making it easily revised away. The overall outlook for growth remains significantly weaker than it was before the referendum.

FALLING POUND, RISING INFLATION

Sterling has lost around 18 percent against the dollar since the vote and is trading at a 31-year low, and near a record low in trade-weighted terms.

A "flash crash" in the pound last week took it well below the nadir foreign exchange strategists in a recent Reuters poll had expected it to reach in the run-up to March, when May says she will invoke Article 50 of the Lisbon Treaty. [GBP/POLL]

That has exacerbated tensions between suppliers and retailers, with both sides battling for profits as margins on imported goods are hit. Britain's biggest retailer Tesco has pulled dozens of Unilever brands from its website in a row over pricing.

As sterling is so weak, inflation is expected to rise sharply from August's 0.6 percent reading. It will average 2.3 percent in the second quarter of next year, exceeding the Bank of England's 2 percent target.

But the highest forecast in the poll has crept up, with HSBC calling for 3.7 percent inflation in 2017.

Ahead of the referendum, inflation wasn't expected near target until towards the end of 2017 at the earliest.

That may not stop the Bank from trimming another 15 basis points from borrowing costs, possibly as soon as next month, sending Bank Rate to a new record low of 0.1 percent, the poll found. It will then stay at that level until the end of 2018 at the earliest.

The pound's fall has given a potential boost to exporters, and recent data have suggested the initial impact of the vote to leave on consumer and business sentiment, as well as the broader economy, has not been as bad as initially thought.

Growth in the third and fourth quarter this year is expected at 0.3 and 0.1 percent whereas in an August poll a 0.1 percent contraction was pencilled in for both quarters, a technical recession. Last month, those forecasts were 0.0 and 0.1 percent.

But with the exit negotiations yet to begin there have been few clues as to what path they will take and forecasts have been tempered for 2017 and 2018. The economy is expected to grow 0.8 percent next year and 1.4 percent in 2018.

In a June poll taken before the surprise referendum result the respective forecasts were for 2.1 and 2.3 percent growth.

The highest 2017 growth forecast in the June survey was 2.7 percent but in the latest poll the most optimistic forecaster had 1.5 percent pencilled in.

(For other stories from the global poll:)

Polling by Sujith Pai, analysis by Khushboo Mittal; Editing by Catherine Evans

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