A key feature of this year’s IMF and IIF Annual meetings in Washington has been renewed concerns about the impact of Brexit.
In the weeks and months following the Brexit referendum in June 2016, a consensus quickly started to emerge that Brexit would be a “non-event”. This was premised on the idea that the exit would be in name only and that in reality most of the current trade and access arrangements would remain largely unchanged – a so-called “very soft exit” or what is now referred to as BENO “Brexit-in-name-only”. Obviously, this did not stop the Pound from weakening (the Pound has depreciated by almost 16% against the US Dollar since 23 June 2016), but other short-term economic indicators have been much more resilient (or even positive) prompting comments that markets and companies are unconcerned about Brexit or that the impact of Brexit will be favourable for the UK. UK manufacturing is certainly benefiting from the weaker pound.
However, at a very recent Conservative Party conference, Theresa May announced that she will invoke Article 50 of the EU Treaty by the end of March 2017, triggering a two year countdown that will culminate in the UK leaving the EU. Importantly, she stressed that “exit means exit”, which has been commonly interpreted as a harder-exit. This change in expectations around the nature and impact of Brexit has been accentuated by a clearer understanding of the process to exit. For example, in this week’s IIF discussion on Brexit all the participants highlighted that while there are at least three or four options on the type of exit deal the UK could pursue, all of the options will take many years (way more than two years) to resolve and get ratified by all the members of the EU. This means that the UK will first have to negotiate a “transition” arrangement within the first two years, before trying to negotiate a final exit agreement. Without the transition agreement there would quickly emerge a large number of important legal disputes. It is also very clear that the UK is a long way from detailing the type of deal they are likely to pursue and that the scope and complexity of the exit is immense. Lastly, the large EU countries are unlikely to approach the exit favourably, while some of the negotiations could become hostile especially considering that there are a large number of important government elections in the EU over the next two years, including within France and Germany. It would appear that in order to get a “good” exit deal (secure maximum access to Europe’s single market), the UK is going to have to be flexible on immigration; but that is at the core of why so many citizens voted for the exit. Also even if the UK can secure preferential access to the EU market post Brexit, without harmonised regulation (for example food labelling) many of the UK products might not meet European standards, while a trade deal that covers services is going to have to break new ground in the area of global trade.
Hopefully, while the Brexit negotiations are under-way the UK can look to strengthen its trade relationships with other key countries, including China, but this is unlikely to fully compensate for the loss of easy access to the EU.
These concerns about the impact of Brexit are starting to be reflected in the BoE’s Agent surveys. In particular, the BoE survey of the intention to invest and hire by UK companies (see charts attached) has slowed sharply since the June referendum and could decline significantly further over the comings months. (We will provide regular updates on the survey). This would support the consensus forecast that while the UK might avoid an outright economic recession in 2017, the growth rate is likely to slow sharply to between 0% and 1% compared with an estimated growth rate of 2.2% in 2015 and around 1.8% in 2016.
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