With just over 200 days until the Brexit deadline, negotiations have become increasingly fraught as the UK political environment has become increasingly turbulent. Market uncertainty has become increasingly elevated as the potential for a “no-deal Brexit” continues to rise reflected in the spike in “no-deal” news headlines and “no-deal” google searches. Consequently, the government is preparing to deliver a contingency plan in the event of a hard Brexit in March 2019, a situation which International Trade Secretary Liam Fox now says has a 60% probability of occurring.
Economy To Shrink by 8% on No Deal Brexit
Despite the growing level of uncertainty linked to the increased risk of a hard Brexit, the base case scenario is still for the UK and the EU to strike a deal allowing for a smoother transition out of the EU for the UK with a transition period beginning in March 2019. However, if this scenario fails to materialize, the economic consequences could be significant as, according to leaked UK government forecasts earlier in the year, in the event of the UK failing to secure a deal, the economy could shrink by 8% over a 15-year horizon. Below are a few of the key factors that could cause this economic contraction.
Unemployment could surge
The hard recession that was forecast in response to a vote for Brexit has yet to materialize. Although it has been a tricky period for retailers as consumers have cut back, import prices have risen and higher minimum wage costs and higher business rates have narrowed margins, spending hasn’t collapsed like many thought it would and the economy has stayed out of recession. One of the key drivers behind this dynamic has been the fact that unemployment has stayed at record low levels.
Although economic and consumer sentiment has been subdued, employment has risen 2% since June 2016 in stark contrast to the heavy declines seen during the two prior periods of economic contraction.
However, as the government begins to outline contingency plans for a “no deal Brexit”, this sentiment could be even worse hit. As media scrutiny of the government’s plans along with the typical tabloid hype about the likely post-apocalyptic nature of a no-deal Brexit begins to take hold, consumer spending could start to seriously dwindle which would then put jobs under threat and see the country lurch close to or into recession.
No Deal could cause major congestion
A no-deal Brexit could cause significant congestion and delays at UK ports, most importantly Dover. With a large percentage of the UK’s trade with Europe done via lorries crossing the channel, the British Freight Transport Association has estimated that even just two-minute delays at customs could cause up to 29 miles worth of queuing on the motorway into Kent. Similar congestion at other British ports could cause just as much disruption with the potential to disrupt supply chains on both sides of the water. For example, 58% of total inbound and outbound tonnage via the Port of London is from either Netherlands or Belgium.
Tighter financial conditions to cause economic problems for both the UK and EU
Financial conditions have been another key reason why the UK economy has remained so resilient since the Brexit vote as credit and interbank spreads have remained stable compared to earlier in the post-GFC years. Indeed, even the initial volatility seen in equity and currency markets quickly dissipated.
However, in the event of a no deal Brexit, the heightened uncertainty could cause a sharp surge in risk-off market behavior fuelling a flight to safety which would see credit spreads widen and volatility surge. Indeed, even ahead of the deadline, if the chances of a no deal Brexit continue to rise, financial conditions are likely to grow tighter, creating difficult conditions ahead of the actual departure date.
These conditions could be exacerbated if financial passporting is removed, creating a sudden shift in market access for banks which should see credit availability dry up for households and business alike.