Fra BNP Paribas:

 Recent political developments in the UK support our view that a shift towards a softer form of Brexit would involve a period of heightened political uncertainty.

 The market focus is on the chances of a near-term leadership challenge to Prime Minister
Theresa May, but we see reasons why her critics within the party will hold off for now.

 Looking through any near-term turbulence, we continue to expect a softer form of Brexit to prevail, which would ultimately be good for markets and the economy.

 But markets might struggle to fully price in a soft Brexit while some uncertainty lingers,
limiting the potential upside for sterling and for higher rates in the near term.

Chequers proposals point to softer form of Brexit
Last week’s Cabinet meeting to discuss the future relationship with the EU resulted in a marked shift in the UK government’s position on Brexit. The key elements of the deal agreed at Prime Minister Theresa May’s official country residence, Chequers, are as follows:

 “a common rule book for all goods including agri-food” under which the UK would
essentially remain in the Single Market for goods trade but have more flexibility than at
present for the services sector to diverge on rules and regulations;

 “strong reciprocal commitments related to open and fair trade” (eg, EU rules on state
aid and consumer protection) and a commitment not to drop standards below current levels;

 “consistent interpretation and application of UK–EU agreements”, which we think
points to a similar setup as for current EEA members and the EFTA court;

 “a new Facilitated Customs Arrangement” whereby goods entering the UK and destined
for the UK would face a new UK tariff regime, but goods travelling to the EU via the UK
would be subject to the EU’s common external tariff.

In addition, while the proposal talks about ending free movement, it also suggests a “mobility framework” – in vague terms, this suggests very limited restrictions on students and those with a job offer already in place. The government is to spell out the vision set out in the Chequers statement in greater detail in a white paper on Thursday.
What to make of it all?

The first point to make is that, in their current form at least, the Chequers proposals are likely to be rejected by the EU.
 Signing up to the Single Market only for goods but not services might be seen as ‘cherry
picking’. Although the Single Market for services is not complete, there are still provisions
within it, for example, on recognition of professional qualifications and passporting rights for financial services firms.
 The EU might not be content with the customs proposals, either. The EU would effectively
have to trust the UK to collect tariff rates on its behalf, which caused it to reject Prime
Minister May’s initial customs partnership proposal. There would also be a concern that
potentially lower UK duties might open up the possibility of fraud, particularly if there were
few or none further checks between the UK and EU.

Although the EU might reject the proposals, the initial response from its chief negotiator Michel Barnier suggests they have at least opened the door for negotiations to re-commence – something the EU is likely to welcome as a step forwards.

The second key point is just how big a shift has occurred between the initial vision of Prime
Minister May’s Lancaster House speech of January 2017 and the Chequers statement.
Although there have been several resignations in its wake, this fundamental shift is nonetheless significant.