COLUMN-Forget Trump. A UK deal with the EU is what matters: Klement

By Joachim Klement

May 13 - The comprehensive trade deal announced by the U.S. and UK governments last week was a damp squib, but that shouldn’t worry Downing Street. The bigger prize is closer collaboration with the European Union, and that could accelerate after the UK-EU summit next week.

The bottom line of the U.S.-UK trade agreement is that most British exports to the U.S. will remain subject to a 10% tariff. This could reduce exports by 0.7% in the next 12 months, based on my calculations using the World Bank WITS trade model.

The EU will likely face a similar fate.

But even though both economies could feel some pain in the short run, they should be able to offset the loss in the medium term with exports to companies in China and other regions that are looking for alternatives to U.S. suppliers.

And, ultimately, they can both almost certainly live with 10% U.S. tariffs over the long run.

Instead, what really matters is the potential for a deal between the UK and the EU. That’s because five years after leaving the block, the UK’s exports to the EU are still three times larger than those to the U.S., and imports from the EU to the UK dwarf those from the U.S. by a factor of six.

The UK’s Brexit deal will be reviewed throughout 2025 and 2026, starting with the summit next Monday in London. It appears likely that both economies will seek greater integration.

REGULATORY ALIGNMENT

One thing is certain: removing the EU’s 10% tariff on British goods will not be possible as that would require the UK to join the customs union, a step that remains politically anathema despite the large economic costs of Brexit.

But there are other ways to ease trade. For example, better aligning regulations with those of the EU could boost British exports by 2.2% to 3.3%, according to a study by think tank Best for Britain and Frontier Economics.

They estimate that the medium-term boost to UK GDP would be around 1% to 2%, depending on how closely UK regulations track those of the EU.

The impact on EU exports to the UK is the same in absolute terms (estimated growth of 10 to 12 billion euros) ($11.11-$13.33 billion), but the percentage gains are obviously smaller because the EU is a much larger economy.

Nevertheless, the EU could potentially offset about half the U.S. tariff hit by agreeing to closer regulatory alignment with the UK.

The UK government is also quietly pushing the "Product Regulation and Metrology Bill" through parliament – legislation that is not nearly as innocuous as it sounds. It would allow UK ministers to fully align regulations on products and services with EU standards at the stroke of a pen, without the need to pass any further laws. That could be a gamechanger.

DEFENSIVE WIN

Importantly, the government of Prime Minister Keir Starmer appears to be interested in more than just lofty rhetoric about shared values and a commitment to regular summits. It is seeking closer alignment on emissions regulation and defence cooperation.

The latter is particularly important for the UK since the EU became Britain’s largest export destination for arms and munitions in 2023, accounting for 46% of all UK defence exports.

And this share looks set to grow given the EU’s newly launched "Readiness 2030" package, which enables the bloc to spend up to 800 billion euros on defence in the next five years.

But this can only happen if UK defence contractors are allowed to participate in the programme. Initially, the EU wanted to exclude them, but it seems defence cooperation will be discussed at the summit, with British access to "Readiness 2030" to be negotiated in the following weeks.

This would be a particular boon for smaller UK defence contractors like Chemring and Qinetiq, which have larger sales in Europe, but it would also help major companies like BAE Systems and Rolls-Royce.

WATERSHED MOMENT

That isn’t to say that greater integration is a done deal. Proponents of a "hard Brexit" would likely denounce this as a betrayal, but there has never been a popular majority for this type of post-Brexit policy.

Similarly, the EU will likely want UK concessions or even a financial contribution to get any deal over the line, which may stress the country’s tight government budget even more. But given all the benefit, that may well be a price worth paying.

While all eyes are on the actions of the U.S., the UK government appears to be quietly working to undo some of the damage done by Brexit. The EU-UK summit could therefore be a watershed moment.

(The views expressed here are those of Joachim Klement, an investment strategist at Panmure Liberum, the UK's largest independent investment bank).

($1 = 0.9003 euros)