EU’s next challenge: Avoiding seismic “Brexit”. Here’s how to keep UK in.

The British are feeling their collective oats right now. Under sensible guidance, the economy has been one of the world’s bright spots of late. And with a nation full of ever questioning innovators, the UK is among the best positioned to meet challenges of the Fourth Industrial Revolution. But that bright outlook could become cloudy, at least temporarily, if it is unable to strike a deal with the 27 other members of the European Union ahead of the UK’s “in-out” referendum later this year. The British position has been clearly articulated – it wants to be part of Europe, but not run by the EU – a partner without total absorption. Internally the message is one of the UK refusing to be priced out of the global economy by being forced to implement what it believes to be misguided economic policies formulated in Brussels. The conundrum is a major challenge for the EU, whose mission, perforce, must be a move towards full integration of all its members. The UK is Europe’s second biggest economy and projected to overtake Germany by the 2040s. Keeping it in the union is as much a priority for Brussels as it must be for London. – Alec Hogg

By Ian Wishart and Thomas Penny

(Bloomberg) — The U.K.’s 43-year membership in the European Union comes into sharper focus in February as Prime Minister David Cameron discovers whether the rest of the bloc will offer him sufficient concessions to convince the British people it’s worth staying.

A Union Jack flag flutters next to European Union flags ahead of a visit from Britain's Prime Minister David Cameron at the EU Commission headquarters in Brussels, Belgium, January 29, 2016. REUTERS/Francois Lenoir
A Union Jack flag flutters next to European Union flags ahead of a visit from Britain’s Prime Minister David Cameron at the EU Commission headquarters in Brussels, Belgium, January 29, 2016. REUTERS/Francois Lenoir

The U.K’s relationship with the EU, troubled by decades of anxiety over waning national power, the euro area’s threat to London’s financial clout, subsidies to French farmers and, more recently, mass migration, may come down to the next few weeks of deal-making. Any accord must offer enough special treatment to allow Cameron to claim victory before an in-out referendum as early as June, without prompting a revolt from other members of the 28-nation club.

“If Britain votes to leave it will be a seismic event,” said John Springford, senior research fellow at London’s Centre for European Reform. “Cameron’s strategy of having a renegotiation and then a referendum has been felt by the other leaders as essentially holding a gun to their heads; there’s been resistance to allowing Britain to set the terms of the future direction of the EU.”

Cameron met EU President Donald Tusk — the man who represents the bloc’s national leaders — in London on Sunday, and they agreed to postpone the circulation of the former Polish premier’s template for a compromise until Tuesday — 24 hours later than planned. The Tusk meeting was preceded by a hastily organized trip to Brussels by the prime minister on Friday for discussions with Jean-Claude Juncker, the man whose candidacy for the European Commission presidency Cameron tried to block in 2014 and whose support he now needs to help forge a deal with fellow EU leaders at a summit in Brussels Feb. 18-19.

Exceptional Circumstances

The commission, the EU’s executive body, has been working on giving the U.K. a so-called emergency brake granting it some power to limit welfare benefits to migrants — Cameron’s most contentious demand — if the government can prove exceptional circumstances. Since any compromise must win the approval of every EU government, Cameron’s room for maneuver is small.

The prime minister used the meeting with Tusk, who traveled to London with his full negotiating team, to press for the brake to be put in place immediately after a referendum and established as a “stop-gap’’ until a permanent solution can be found. Tusk’s draft agreement for the February summit will now say that current circumstances in the U.K. meet the threshold for bringing in the brake, Cameron’s office said after the meeting.

David Cameron, U.K. prime minister, reacts during a special session at the World Economic Forum (WEF) in Davos, Switzerland, on Thursday, Jan. 21, 2016. World leaders, influential executives, bankers and policy makers attend the 46th annual meeting of the World Economic Forum in Davos from Jan. 20 - 23. Photographer: Matthew Lloyd/Bloomberg
David Cameron, U.K. prime minister, reacts during a special session at the World Economic Forum (WEF) in Davos, Switzerland, on Thursday, Jan. 21, 2016. World leaders, influential executives, bankers and policy makers attend the 46th annual meeting of the World Economic Forum in Davos from Jan. 20 – 23. Photographer: Matthew Lloyd/Bloomberg

While the prime minister’s demands for EU reform won’t significantly change the bloc or the U.K.’s relationship to it, they might give him enough ammunition to make the case to the British electorate for the country to remain wedded to the continent.

That matters to all Europe for reasons of trade and economics, but also because Britain has been a flag-bearer for the free market and EU enlargement toward the East, even as it refused to go along with more integrationist policies like the single currency and the removal of border checks.

The pound fell to a 5 1/2-year low against the dollar Jan. 21 as investors started to focus on the risks of a potential U.K. exit from the EU. Last week, Barclays warned that markets appeared to underestimate the impact of the referendum as it designated the EU summit a “key risk event.” Berenberg Bank raised its assessment of the chance of a vote to exit to 35 percent.

Conservative Vote

Faced with a tide of anti-EU sentiment in his Conservative Party and a substantial part of the electorate that favors Britain leaving the EU, a so-called Brexit, Cameron has sought to win agreement from his fellow EU leaders in three other broad areas alongside welfare: safeguarding the rights of non-euro countries like his; abolishing the U.K.’s obligation to “ever closer union”; and stripping back regulations that hamper competition.

But it’s the demand to limit access to welfare payments for non-British EU citizens in the U.K. that has proved most contentious with governments in countries such as Poland and Hungary. They have sent thousands of people to set up home in the U.K. and say the move would make their countrymen and women second-class citizens in a club where everyone is supposed to be equal.

Merkel Talks

There have been signs that negotiations aren’t going to plan. Cameron canceled a planned visit to his counterparts in Denmark and Sweden on Friday to meet with Juncker instead. He said afterward that the proposals were “not enough.” On Sunday, the premier’s office said “much progress” had been made in the 48 hours after meeting with Juncker and British officials are due to travel to Brussels on Monday morning to continue negotiations.

The prime minister will have the opportunity for face-to- face talks with German Chancellor Angela Merkel, the EU’s chief power broker, twice over the next two weeks in the run-up to the summit: on Thursday, when she will co-host a conference on Syria in London; then on Feb. 12 when he is scheduled to make a speech on Europe in Hamburg.

An opinion poll published on Friday showed that exactly half of British voters would back staying in the EU while 38 percent want the U.K. to leave. The survey, conducted by Ipsos MORI for the Evening Standard, indicated that 58 percent have already decided how they would vote in a referendum. The 12- point gap is the narrowest in an Ipsos MORI survey since 2012 and compares with a 34-point lead for the “In” campaign in June, the newspaper said. The polling company asked 1,027 adults by telephone on Jan. 23-25.

While phone polls have shown consistent leads to stay in, more frequent online polls have suggested the race is much closer.

“As these negotiations are highly technical, it is hard to see how any result — even if presented as a victory for David Cameron — can be so compelling to the British people that they would lose their EU-skepticism,” said Carsten Brzeski, chief economist for ING-DiBA in Frankfurt. “The rest of the European Union, therefore, is well advised to think of the unthinkable and prepare for a Brexit.”