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What Theresa May’s Speech Means for the Brexit Economic Outlook

Six months after taking over as the U.K.’s Prime Minister, Theresa May finally set out in detail her approach to taking the country out of the European Union.

In a speech to foreign diplomats in London Tuesday, May confirmed that the country will leave the EU’s Single Market, and seek to negotiate entirely new trading arrangements with the rest of the bloc. That’s the opposite of what business wanted, and yet the pound has surged in reaction. It’s having its best day against the dollar since 2008, up over 2.7%. How to explain the apparent contradiction?

There was little in the speech that was truly new, and even less that was surprising. Downing Street had already leaked the most negative news – that the U.K. would leave the Single Market – over the weekend. To a large extent, that left markets with little to do except “buy the rumor and sell the fact.” The rebound was made easier by Donald Trump’s complaints to The Wall Street Journal about the dollar being too strong, which have caused some dollar bulls to draw in their horns for now.

The most important thing about the speech was arguably that it provided clarity about the government’s position, even if that position is a grim one for many businesses. Since taking over in July, May has struggled to contain a public argument between senior ministers over strategy, one that boiled down to a decision on whether to prioritize frictionless trade with Europe, as preferred by business, or to curb immigration and reassert the primacy of U.K. courts, as preferred by most voters who backed Brexit.

“We now know that we will be leaving the Single Market, and while there will be firms who regret this, they will at least be able to plan on that basis,” said Allie Renison, head of Europe and Trade Policy at the Institute for Directors think tank in London.

The second important detail of the speech was May’s embrace of a “phased implementation period” that would allow a gradual transition to whatever new trading arrangements are agreed.

May is walking a tightrope here: the financial services industry is terrified of “cliff edge” effects if it abruptly loses the right to be the EU’s banker, insurer and accountant. Under EU law (the so-called Article 50 clause of the EU Treaty), the U.K. will leave the Union no later than two years after May formally notifies it of its intention to leave.

The EU has never negotiated a trade deal in such a short timeframe, and many fear a crippling legal vacuum after 2019. But at the same time, the Euroskeptic wing of May’s Conservative Party fears that business and other “Remainers” would use a transitional phase to bog down the process of leaving, keeping the U.K. in a “permanent political purgatory,” as she called it Tuesday.

Simon Tilford, deputy director at the Center for European Reform in London, argues that a transitional deal, one that would run in theory from 2019 through 2022, will still be hard to nail down, as the EU will insist on a high degree of freedom of movement in that time. That would leave May unable to deliver a meaningful cut in immigration before the next election in 2020.

Thirdly, May promised that parliament would have a vote on the final agreement that the U.K. hammers out with the EU. The most likely outcome is that the vote will rubber stamp whatever the government agrees, because the alternative will be that “cliff edge” dreaded by business. As such, the most likely alternative to the “Hard Brexit” now being negotiated is a disorderly one.

An alternative interpretation, that Parliament could give up on the whole idea of Brexit when it sees the painful trade-offs involved, seemed to be partly responsible for the sterling rally, but is politically highly unlikely. That would require an effective, pro-EU opposition, and the center-left Labour Party is currently incapable of providing that, having only just woken up to how hostile its traditional voter base has become towards immigrants.

While a disorderly Brexit would harm the U.K. more than the EU, May is gambling that the cost to Europe would be high enough to ensure that the EU doesn’t go out of its way to punish the U.K. for leaving.

“That would be an act of calamitous self-harm for the countries of Europe and it would not be the act of a friend,” May said.

But arguably the most important thing about May’s speech was not what was said, but how it was said.

“We will continue to be reliable partners, willing allies and close friends,” May said (she used the words “friend” and “friendship” 18 times), promising that Britain wouldn’t try to unravel the EU any further. “It remains overwhelmingly and compellingly in Britain’s national interest that the EU should succeed,” she stressed.

In the final analysis, May didn’t say much that her more combative Euroskeptic ministers would disagree with. But her delivery was, as Tilford put it, “calm and conciliatory.” Staying that way over the next two years of intense negotiations will make all the difference between a Hard Brexit and a truly horrible one.