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Analysis
Next UK-German monetary struggle

Next UK-German monetary struggle

Berlin's quest for EU bridging finance

by David Marsh in London

Tue 19 Sep 2017

The next big European struggle between Germany and Britain hinges on money. This is the key to a prime question hanging over British negotiations to leave the European Union: the amount of help Germany will give the UK to secure an acceptable deal both on the exit and the future relationship.

At present Britain pays in to the EU an annual gross sum of around £13bn (including the rebate secured in the 1980s but not including EU payments made to the UK of £4.5bn). The greater the assurance that Britain can pay a similar figure during a two- to three-year transition period after the UK leaves the EU in April 2019, the smoother will be the path of agreement with Germany.

Berlin, as the main EU budgetary contributor, is relying on an acceptable bridging deal with the UK to prevent an uncomfortable funding shortage later in the decade. The problem for Prime Minister Theresa May is that any proposal for the UK to pay, say, £10bn per year over three years from 2019 would be anathema to many influential Conservative backbenchers – as well as several key ministers within her cabinet. This could not only scupper the exit process but also bring down May's government.

The rebels include Boris Johnson, the Brexit-backing foreign secretary. Irked by widespread belief that he is losing influence over the EU withdrawal process, Johnson challenged May's authority with a lengthy newspaper article on 16 September containing misleading figures on the UK's present budgetary support. In what appears a deliberate attempt at rebellion, Johnson set out a path to a speedy exit without the transition period favoured by Phillip Hammond, May's chancellor of the exchequer.

Much will depend on the politics and psychology of Chancellor Angela Merkel's relatively solid relationship with May. Those close to Merkel say both leaders share the common characteristic of not making up their minds about fundamental positions until circumstances develop in appropriate directions. This trait has shaped Merkel's policies on many major issues including finance, nuclear energy and refugees. The possibility of accidents, however, may rise during difficult coalition-building in Berlin after next Sunday's Germany elections.

Given the sluggish pace of negotiations between the main British and EU negotiators, David Davis and Michel Barnier, accompanied by considerable play-acting, Barnier will probably tell European leaders that the UK has not done enough to allow negotiations on the future relationship to start in October.

Since nearly all sides are anxious to achieve an agreement on an orderly UK exit, the chance of a deal in 18 months is still relatively high. But there is certain to be brinkmanship and intrigue over a potential disruptive March 2019 departure in a so-called 'cliff edge' lurch out of the union.

In a speech in Florence on 22 September, May will spell out latest thinking on a post-2019 transition. She will lean much more towards Hammond's rather than Johnson's interpretation of a post-Brexit arrangement. But German compliance with whatever deal the British put forward is uncertain. London's overestimation of assistance from Germany to secure the UK's economic and political ambitions has been a constant feature of London's dealings with Europe over several decades. This came to the fore in Prime Minister John Major's hope in 1992 that Chancellor Helmut Kohl and the Deutsche Bundesbank would help Britain's parlous position in the exchange rate mechanism – the subject of the OMFIF Press book Six Days in September.

At the launch in London on 15 September, Sir Paul Tucker, former deputy governor of the Bank of England, voiced scepticism over the contrition of Helmut Schlesinger, then Bundesbank president, who apologised in the OMFIF book for his role in provoking the upsurge in speculation that culminated in the UK's 16 September ERM departure. Tucker recounted how he and Robin Leigh-Pemberton, Bank of England governor, had spoken to Schlesinger on the evening of 15 September asking him to withdraw a reported remark questioning sterling's ERM parity. Schlesinger said he was unable to do this, though the Bank offered to help with technical assistance, showing, according to Tucker, that Schlesinger intended all along to draw attention to what the Bundesbank considered to be the pound's ERM overvaluation.

David Marsh is Managing Director of OMFIF.

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