LONDON — With four months to go until Brexit day, it is still far from clear whether the U.K. will exit the EU with a deal.
The fate of the draft Withdrawal Agreement hangs in the balance amid doubts that U.K. Prime Minister Theresa May can assemble a majority behind it in parliament. That would almost certainly mean an economic hit to the U.K. — but how bad? And when?
The answers to those questions will be key to the politics. An immediate crash in sterling and the price of U.K. stocks could be enough to jolt British MPs to vote through a deal on a second attempt, but any hit to the real economy will likely take months and years to play out.
“A true no-deal scenario would mean that the U.K. reverts to WTO trading rules without a transition period. This would represent a calamity for the U.K. economy and financial markets,” said Ranko Berich, head of market analysis at Monex, a foreign exchange provider.
POLITICO asked experts at a variety of financial and consulting firms in the City of London what impact they think no deal would have on three key economic indicators:
Forecasts for the impact of a no-deal Brexit range from bad to very bad. Some estimates suggest a further slowdown in already disappointing growth, but many others suggest an outright recession.
On the more optimistic side, Commerzbank expects that growth will only be about 0.25 percentage points lower than the no-Brexit baseline, with real GDP lower by 1.5 percent in the short term and by 4.5 percent after eight years. But, “these small changes cumulate to significant degrees if left unchecked,” it warned.
Others predict far worse outcomes. Credit Suisse, as well as forecasting firms Fathom Consulting and Capital Economics, suggested the U.K. economy will contract. Credit Suisse said the U.K. could experience a “short-term recession” with a GDP contraction of between 1 and 2 percentage points. Capital Economics forecasts GDP growth falling to -0.2 percent in the case of a disorderly, no-deal Brexit. Fathom Consulting is even more pessimistic, with GDP growth forecast at -0.8 percent. “The growth impact may be larger still if some of the more pessimistic predictions about supply chain disruptions, and general panic, etc., come to pass,” says Andrew Brigden, chief economist at Fathom Consulting.
Some forecasters suggest it is possible to have an “orderly” reversion to WTO rules in a no-deal scenario, where the negative impact would be dampened. The National Institute of Economic and Social Research forecasts growth would slow to 0.3 percent in 2019 if there is an orderly no-deal, while Capital Economics suggests the U.K. would be saved from recession, bringing GDP growth to 1 percent in 2019. But time is quickly running out for the government to put in place the necessary preparations to make such an exit “orderly.”
Value of sterling
All expectations are that the pound would fall in a disorderly no-deal scenario. In its November Inflation Report, the Bank of England says a smooth transition to a deal would cause market participants to “expect a smaller hit to U.K. real incomes than currently, causing the exchange rate to appreciate. In contrast, a disruptive withdrawal from the EU would inspire more pessimistic views, pushing down sterling.”
But the question is by how much, and when? Markets will not wait for March 2019 to react — rather, sterling would take an immediate hit as soon as it became clear no deal was to be struck. Many expect sterling would immediately fall at least as much as it did after the referendum — by 10 percent — dropping to around 1.2 or 1.15 against the dollar.
But it could keep falling after that — after the referendum, sterling continued to fall, making the overall drop 17 percent after six months. Credit Suisse analysts expect sterling to fall even more than 10 percent in a no-deal scenario, because the referendum drop was not based on actual economic disruption. “This time around a no-deal Brexit would entail real and immediate disruption,” they write. However, Capital Economics suggested that longer term the drop could be more limited as the pound was overvalued before the referendum, whereas this time it would not have as far to fall.
The fall in sterling would push up inflation. That would likely be intensified by the sudden disruption to trade and migration, which would probably drag supply of goods and services below demand, pushing up prices. “The hit from the sudden introduction of tariffs and border crossings will push inflation markedly higher, made worse with the weaker currency. And that is where the pain will be felt for households,” said Jennifer Lee, director and senior economist at BMO Capital Markets.
As trading barriers go up, prices of inputs that go into making goods would go up; meanwhile, lower immigration means lower productivity in the immediate term as companies struggle to fill vacancies. “We would not be surprised if inflation were to surpass 3 percent once more and remain persistently above the 2 percent target over the next few years,” according to Capital Economics analysis, which puts the consumer price index at 2.9 percent next year if there is no deal, and 3 percent in 2020. Fathom Consulting suggested inflation would rise to 2.7 percent in 2019 in the event of a no-deal outcome.
The headquarters of the Bank of England in London | Adrian Dennis/AFP via Getty Images
What exactly is driving the inflationary impact of a messy no-deal Brexit will be crucial for determining what comes next — the BoE isnt likely to raise interest rates in the face of inflation driven mostly by a temporary dive in sterling. In its November inflation report, however, the bank says if inflation were driven by the sudden supply disruptions, it could then be forced to act, raising rates despite the economic slowdown.
“This would weigh on growth, which would take a severe hit that the BoE would struggle to cushion with loose [monetary] policy due to inflationary risk,” said Monexs Berich.
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