Is the UK Heading Towards a Recession?

The UK will slide into recession whether it leaves the EU with a deal or without one and the Bank of England will be forced to cut interest rates, says Janus Henderson's Simon Ward

David Brenchley 28 March, 2019 | 10:32AM
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Theresa May Brexit March 2019

A no-deal Brexit is more likely than people think, but the UK is likely to slip into recession whether it eventually leaves the European Union with a deal or without one, according to Janus Henderson’s Simon Ward.

The European Council recently agreed to delay Brexit until May 22 if Prime Minister Theresa May’s deal is approved by MPs once it is put in front of them for the third time. If the deal is rejected once again, the UK has until April 12 to put a new plan in front of European leaders.

European Council President Donald Tusk said at the time he was “hoping for the best”, noting “almost all is now in the hands of the UK Parliament and Mrs May’s Government”.

MPs have already narrowly voted to take no-deal off the table, raising hopes that the UK will not crash out of the EU without a deal. However, the vote is not binding and there’s every chance a hard Brexit could still happen. Last night's indicative votes brought the UK no closer to resolving the Brexit paralysis.

In fact, Ward, chief economist at Janus Henderson, puts the probability of no-deal happening at 40% – much higher than many now believe.

On the other hand, he thinks the likelihood of May’s deal getting through Parliament – hitherto the base case for many commentators – at a lowly 10%, “and that might be generous”.

The most likely scenario, which he scores at 50% probability, is that the deadlock in Parliament continues and we get a General Election, which “won’t resolve anything”. That’s largely because of the implausibility of the Conservatives coming up with a policy all its MPs can agree to, such is the divergence of opinion from different wings of the party.

Threat of a No-Deal Brexit Remains

But the potential for a no-deal Brexit is there – and Ward thinks, contrary to popular opinion, it will be foisted upon the UK by its continental counterparts.

“I would say that the risk of no-deal doesn’t so much come from the UK; I think there’s a risk that EU leaders will decide enough is enough and pull the plug,” he explains.

“I’m sure there is willingness on the EU side to give us as much time as we want or need, but I’m not sure that time is going to help. We’ve already had a very long time.

“Tusk is probably one of the softer people in terms of making the decision. I think there are other leaders who maybe are thinking: ‘This is getting ridiculous now. Do we really want a new batch of anti-EU MEPs coming into the European Parliament this year?’.

“A lot of companies in the Eurozone have made significant preparations for a no-deal Brexit. I think some of those companies would prefer for that to happen rather than for the uncertainty to be prolonged.”

But the reason Ward thinks the risk of a UK recession soon is higher than in other regions like the Eurozone is only partly Brexit related. In fact, he says a recession is likely whether or not it’s a no-deal Brexit.

The first two red flags are a sharp deterioration in business confidence this year so far, as well as weakness in the the housing market, a key bellwether of the UK economy. Elsewhere, UK GDP growth in the fourth quarter of 2018 was the weakest seen since 2012.

Recession Indicator Flashes Red

But the key indicator he uses to assess prospects for the UK economy in the coming year is currently very much flashing danger signals.

He compares the level of real money – the total amount of money in circulation – in December and the level of share prices in December with the level of real money and share prices the previous December.

“When both have been higher, that has usually signalled strong GDP growth in the subsequent calendar year,” he explains.

However, at the end of 2018, both of these indicators were lower than they were at the end of 2017. “Historically, when that has been the case, GDP in the subsequent calendar year has grown by only 0.3%.”

Should a recession hit, the Bank of England has little ammunition on the monetary front, with interest rates at a lowly 0.75%. The Bank’s Monetary Policy Committee last raised rates in August 2018, but suggested if we get a smooth and orderly Brexit it may hike once more before the year is out, taking the base rate to 1%.

But Ward is not impressed. He think the August hike was a mistake. The suggestion rates could move higher still in the coming months is “incredible because we’ve seen very weak monetary trends and a collapse in business confidence in the last couple of months”.

“They haven’t got a lot of scope to ease policy, so that argues strongly for acting early and pre-empting it,” Ward adds. “I think rate cuts are coming much sooner than people expect in the UK, but I think [the Bank is] already too late to prevent significant economic weaknesses here.”

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David Brenchley

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