EU Expects 'Hard Brexit' as Talks Falter, Braces for Economic Downturn

As political turmoil in the UK weighs on the progress of the Brexit talks, some European central bankers are expecting a “hard Brexit” scenario, and the subsequent sudden disruption of many economic ties between Britain and the continent.

Kristian Rouz — Whilst the political uncertainty in the UK hampers  Brexit negotiations with the EU,  European policymakers are becoming increasingly confident of the possibility of a "hard Brexit." Such a scenario, they say, would send shockwaves across the EU economy, as trade, migration, and financial ties between Albion and the continent would be disrupted.

The resulting instability would hamper the overall economic performance of the European continent.

German central banker Andreas Dombret says a "hard Brexit" scenario would hit economic productivity and efficiency on the continent, most prominently, in the Eurozone. He says losing access to the UK's highly-developed financial infrastructure could damage European lending and affect capital flows.

"The banks need to plan for a hard Brexit," Dombret says. "It would be our, as well as the Bank of England's recommendation, to start planning early on… There will be  implications for the economy, mainly on the British economy but also on the rest of the EU economy."

Dombret is a member of the Executive Board of the Deutsche Bundesbank, and in the past he has served as Vice-Chairman of Bank of America.

He expects significant changes in the financial sector following a possible "hard Brexit." Dombret expects many banks and other financial institutions to move their offices from London, resulting in tougher banking sector competition on the continent.

The Eurozone, for example, has been struggling to end its ultra-loose monetary environment by increasing base borrowing costs from the current zero and negative levels. However,  increased competition between commercial banks will force them to lower their effective rates, making it harder for the European Central Bank (ECB) to end its quantitative easing.

Besides, many European banks face declines in capitalization and profitability. Italy barely avoided a banking system collapse earlier this year, as the amount of non-performing loans (NPLs) is nearing its all-time high. Reaching far beyond Italy, banking sector inefficiency, coupled with the competition from lenders arriving from across the English Channel, would impair the overall performance of the banking sector.

Currently, London beats New York, Hong Kong, and Singapore in global financial ratings, and no other European city is in the top 10. This despite the Frankfurt Stock Exchange's bid to acquire the London Stock Exchange (LSE), in order to form the world's largest financial hub, and offset the possible "hard Brexit" headwinds.

Chief EU Brexit negotiator Michel Barnier says his team is putting every effort into avoiding an "unorganized" Brexit. However, he cites the political turmoil in the UK as the main obstacle to a Brexit deal. At the same time, he is also urges businesses to factor in the risks associated with a "hard Brexit," as there is little clarity or progress on the matter thus far.

"We want to be ready for all eventualities, including 'no deal'," Barnier warned.

Several UK-based banks might relocate their business to either Dublin or Frankfurt, however, others might stay in the UK and enjoy an expansion of their business. Besides, the still-robust UK economy and the cabinet's aim of striking trade deals with London's key partners, including the Commonwealth countries and the US, provide a theoretically bright perspective for the banks that decide to stay.

Meanwhile, a political standoff between UK Prime Minister Theresa May and Foreign Secretary Boris Johnson limits the British chief negotiator David Davis' ability to offer a solid Brexit deal to the EU. Whilst the UK has agreed to pay a 20-billion-euro "Brexit bill," the EU has raised its demand to 60 billion euros.

PM May also confirmed a "no-deal" scenario is becoming likelier.

EU officials are trying to coerce the UK into accepting a Norway-like status, which is being in the single market, yet accepting the rules the nation has no vote on — a proposal the UK has repeatedly rebuffed.