At the time of writing, EU-UK trade negotiations continue. I have been pencilling a ‘skinny’ Brexit into my central outlook for the economy, but is by no means a given. Time is now very tight before transitional trading arrangements cease on 31 December.
How would a World Trade Organisation (WTO) Brexit change the outlook for the UK economy? In short, I’d expect somewhat less growth, higher inflation and more policy stimulus. Given how unusual the particular circumstances of Brexit are, however, it is wise to treat predictions of the scale of any impact with caution.
(Really) bad timing for the economy
The background economic conditions for the UK economy are clearly very tough. These aren’t the ideal conditions to experience a sudden and sharp increase in trade barriers with the region the UK trade most with. The UK economy has been a relative underperformer during the Covid-19 crisis, with GDP as of October, still some 8% below pre-crisis levels and the labour market already heavily disrupted by Covid. There is a good chance that the Covid backdrop worsens post-Christmas, just as the UK and EU start trading on new terms and where some UK ports already appear to be seeing significant problems.
Covid dominates the picture for GDP growth in 2020 and 2021 so that, even with a no deal outcome, the UK is still likely to see positive growth next year driven by a post-Covid, vaccine-driven return to some semblance of normality. Brexit is expected to have much more modest up-front effects than the Covid crisis, but be a longer-term drag on growth.
Shaving growth forecasts
While a no-deal Brexit would put a dent in my 2021 forecasts for the euro area economy, the adjustment would be larger in the UK (in line with academic studies on likely relative impacts). Compared to my previous base case, the first half of 2021 in particular would be much more subdued as both sides start to adjust to WTO terms for trade, likely experiencing some significant disruption at the border. This isn’t just about UK exporters suddenly facing higher tariffs, but also about how a whole swathe of new rules will actually be applied on the ground. At this stage, I would envisage shaving some 2pp off UK GDP growth for the whole of 2021 in a WTO Brexit scenario.
A no deal Brexit outcome is particularly likely to affect the UK economy in 2021, but also weakens growth further out. It will take time for businesses to re-orient, less openness is associated with lower productivity and the coming upheaval to immigration policy may also have implications for population growth and labour market flexibility.
Some policy offsets
Additional fiscal and policy support is assumed to include the Bank of England cutting policy rates into (slightly) negative territory (though not as early as this week – stepping up the pace of asset purchases seems more likely for now). As for fiscal policy, I would assume a package of Brexit support measures and an extension of the furlough scheme from March 2021.
In the event of ‘no deal’, sterling is likely to depreciate. Alongside an assumption of an impact from tariffs and trade disruption (e.g. shortages in some products), UK inflation would likely be higher than expected in 2021 (I’ve pencilled in an extra 0.5pp or so, but much will depend on the path of sterling) and 2022.
Not the end of the story
‘No deal’ is unlikely to be the last word on UK-EU trade negotiations. A number of decisions and agreements between the two sides would be plausible that could somewhat ease the shock (e.g. temporary contingency measures around the transport sector). Given how deeply the UK and EU economies are entangled, it would not be at all surprising if broader on-off trade talks restarted in some form or another in 2021. At any rate, economists are unlikely to stop ‘banging on about Brexit’ and its impact for quite some time.
The views expressed are the author’s own and do not constitute investment advice.