Last week’s sterling flash crash was over in minutes. But the perception of instability that hangs over the U.K. after a week of political drama may be harder to dispel.
Prime Minister Theresa May was successful in her first two months in office in restoring calm following the chaotic aftermath of the June Brexit referendum. By refusing to be rushed into quick decisions on Britain’s future relationship with the European Union, she raised hopes of a relatively smooth Brexit, which was reflected in the swift recovery in the economy and the markets from the initial referendum shock. But her speeches, and those of some of her colleagues, at last week’s Conservative Party conference have fueled anxieties among investors and companies over the direction in which the U.K. is now heading.
Those anxieties only partly relate to Brexit itself. Mrs. May has signaled what was already widely assumed: that the U.K. is heading for a hard form of Brexit in which it likely quits the EU customs union and single market. That is the implication of her pledge to reclaim full control of immigration to Britain and to remove the U.K. from the jurisdiction of the European Court of Justice.
Officially, the U.K. hasn’t made any decisions on what future relationship it wants to pursue with the EU, and there are still some in the government pushing for a softer form of Brexit, if only to avoid any fiscal damage should the U.K.’s financial-services industry lose unfettered access to the EU market. But a “soft Brexit” has never looked like a politically viable option, not least because the U.K. is unlikely to consent to abide by rules over which it has no control.
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Mrs. May’s other Brexit-related announcement also points to a hard deal for the U.K. By committing to invoke Article 50 of the Lisbon Treaty—thereby setting the clock ticking on a two-year exit negotiation with the EU—by the end of March 2017, the U.K. has given up one of its few points of leverage over the Brexit process. That may have been politically unavoidable, given demands from factions of her party and from business not to prolong the uncertainty. But it does mean the U.K. will now go into the negotiations without any commitment from the EU to transitional arrangements or to extend the negotiating period beyond two years that some in the U.K. had wanted.
It also means the EU will now enter the negotiation holding the better cards. The U.K. has the most to lose if the two sides fail to reach a full agreement by the end of the two-year negotiating period and are obliged to trade on World Trade Organization terms. French finance minister Michel Sapin made clear the EU will press this advantage, telling The Wall Street Journal that France will insist on all aspects of the divorce and future trading relationship being agreed in two years.
What appeared to also rattle the markets last week was the vision that Mrs. May and other ministers set out for a post-Brexit Britain. Part of this vision seemed to hinge on reducing the number of foreigners: in schools, in the health system, and in British-based companies. Mrs. May also appeared to take aim at the international business and financial elite who have made their home in the U.K., telling them that “if you are a citizen of the world, you are a citizen of nowhere.”
Mrs. May also set out an economic vision designed to address working-class concerns over perceived failures of globalization that appeared to have been lifted from the opposition Labour Party. This includes a new industrial strategy that would identify and support “strategic industries,” a policy to add workers to corporate boards and controls on energy prices. She also appeared to take aim at the independence of the Bank of England with criticism of its quantitative-easing program.
At last week’s annual meetings of the International Monetary Fund in Washington DC, there was widespread shock at the direction in which Mrs. May appears to be taking the U.K. To many observers, this apparent policy pivot has raised fears that post-Brexit Britain will turn inward, rather than taking the opportunity to embrace a future as an open, business-friendly economy.
The danger for Mrs. May if this perception takes hold is that she risks alienating three groups vital to her own success.
The first is international businesses, whose investment is crucial to the long-term economic fortunes of a country that currently runs a near 6% current-account deficit. Many of these companies use the U.K. as a hub to serve European markets and rely on the EU’s current freedom-of-movement rules to ensure they can recruit the necessary foreign talent.
The second is European governments, whose goodwill is vital to securing a good Brexit deal. Many EU governments, including France and Germany, have already reacted to signs of anti-foreigner sentiment in the U.K. by hardening their own rhetoric toward the British government.
The third group is Mrs. May’s own parliamentary colleagues, who won a general election only 18 months ago. Many on both sides of the Brexit divide may wonder why they are now being asked to back policies that appear to have been borrowed from their defeated Labour and UK Independence Party opponents.
With a parliamentary majority of only 17, Mrs. May’s reputation as a stabilizing force may fall victim to her ambitions.
Write to Simon Nixon at simon.nixon@wsj.com
