No Deal Brexit Could Lead to Recession, says AXA

The UK economic outlook for 2019 is dependent on the Brexit deal, says AXA Investment Manager's David Page

AXA Investment Managers 31 December, 2018 | 12:26PM
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This article is part of Morningstar's "Perspectives" series, written by third-party contributors.

Brexit Theresa May UK economy stock market FTSE recession

The outlook for 2019 and beyond remains dominated by the UK’s decision to leave the European Union and the path it follows thereafter. We continue to believe the bleak implications that the UK would face, if it left without a deal – and particularly without a transition in March – will force a political acceptance of the arrangement that the government has brokered with the EU, or a mildly amended version.

Accordingly, we envisage that the UK will enter a transitional exit, to a softer end-state than has been suggested for much of the process. Yet such an outcome is far from guaranteed and while the UK and the EU would clearly not choose a more abrupt withdrawal, miscalculation may result in that outcome, meaning there would most likely be materially adverse consequences for the British economy.

Yet looking beyond the short-term uncertainty, the UK may find that whatever the outcome, the environment could become all the more difficult, as global economic activity materially wanes in 2020, as risks of a pernicious global downturn grow.

No Deal Outlook Risks Recession

Even now the chances of “no deal” are high. The government’s acceptance of a customs union resolution of the border issue reduces the impact of Brexit to migration control. This has made domestic ratification of the current deal difficult. In the case of no deal without transition, business spending would weaken as firms increased overseas investment.

Sterling would fall further, generating inflation and weighing on consumer spending. Exports would also struggle as trade was no longer covered by the EU’s FTAs. These factors would slow demand and such an abrupt rupture would additionally deliver a supply-side shock. UK ports would be forced to check all goods entering the UK, which they have warned they are unprepared for and estimates suggest a 75% to 88% reduction in goods coming into the country, in the immediate aftermath. Quite apart from the implications for the UK’s 50% of imported food, this would severely constrain UK manufacturing supply chains, limiting output.

The extent of this impact is difficult to predict without historic precedent, but we suggest its effect would be significant, resulting in a recession. The severity of such an outcome could see the UK attempt to forestall this by seeking to extend Article 50 – albeit not for further negotiation but to prepare for such an exit.

This would mitigate some of the supply-side shock, reducing, but not eliminating the adverse impact on the economy. However, such a postponement would require the unanimity of the 27 EU remaining member states.

Beyond Brexit, Resynchronising with Global Cycle

Beyond 2019, the longer-term outlook for UK will also be governed by a re-synchronisation with the global cycle. Material deceleration in US economic activity and more modest slowdowns in China and Europe will leave UK trade-weighted demand growth for UK goods and services softer. In a benign post-Brexit path, we believe the UK will have sufficient, idiosyncratic pent-up demand to buck the global trend in 2019 and 2020.

We forecast the catch-up in investment spending, stronger consumer spending and easier fiscal policy to offset the worsening global headwinds that will tighten financial conditions and worsen net trade. Together, we forecast this seeing UK GDP growth rise by 1.8% in 2020, still in excess of trend, despite the global deceleration.

However, in the event of a malign Brexit, a material supply-side shock may only begin to ease in 2020, as ports increase capacity to cope with the necessary customs checks.

While the UK economy might begin to post a tentative recovery in growth, it would do so from a more enfeebled position and it would not be as well placed to withstand the expect slackening of global growth.

Monetary policy to tighten unless the economy turns While the Bank of England has warned that it would assess changes in demand, supply and the exchange rate, before judging the correct course of monetary policy, we still consider an abrupt exit in March next year as likely to warrant modest easing in monetary policy.

In such a case, we would envisage interest rates falling back to 0.25% and the prospect of quantitative easing before the end of 2019. Equally, a Brexit deal that results in economic acceleration, further above trend in an economy the BoE already assesses has closed its output gap, points to a need for more policy tightening.

In our central forecast, we therefore expect the Bank’s Monetary Policy Committee (MPC) to resume tightening policy. The Brexit uncertainty, however, is highly likely to last for most of Q1 2019. We forecast that the Bank will tighten policy in May 2019, again in November and twice in 2020. The final hike to 1.75% is likely to prove contentious as signs of global deceleration gather. However, domestic inflation pressures appear likely to dominate.


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