Strategy & economics
Whatever happens with Brexit, uncertainty will persist
A “no-deal” Brexit is likely to tip the UK into a recession, but even an agreed withdrawal will leave businesses unclear about the future
The UK’s growth figures for the last three months of 2018 were disappointing, ringing alarm bells about the economic fallout of a potential “no-deal” Brexit.
The UK is facing the worst growth outlook since 2009 and almost every dataset is now weakening.
Most notably, business investment contracted for the fourth consecutive quarter amid intensifying Brexit uncertainty and the prospect of a “no-deal”. Elsewhere data showed the manufacturing sector entered a recession and construction output tumbled. Even the comparatively resilient services sector saw a drop in growth.
We heard some high-profile announcements from companies moving operations or headquarters away from the UK and, according to the Purchasing Managers Survey, UK companies are stockpiling at the fastest pace since that measure began.
What happens next?
We think that in the event of a “soft-Brexit” sentiment will improve, but business investment is unlikely to rebound back to previous levels. This is because even with a withdrawal agreement in place, two years of uncertainty will persist until an eventual trading relationship with the European Union is agreed.
In the event of a “no-deal”, the UK is likely to enter a recession this year as investment and consumption plunge.
What about UK monetary policy outlook? The Monetary Policy Committee (MPC) kept policy unchanged at its February meeting as expected. Heightened Brexit uncertainty and global headwinds led the MPC to slash UK growth forecasts: 2019 growth is now forecast at 1.2% (down from 1.7% in November) and 2020 growth was revised down to 1.5% (from +1.7%). Aside from Brexit, the MPC also revised down its global growth forecasts.
Inflation forecasts are little changed with CPI projected to rise to +2.1% by the end of 2021.
Despite these more bearish near-term growth forecasts, the overall policy guidance remains unchanged. If there is a smooth transition on Brexit, then an ongoing tightening of monetary policy at a “gradual” and “limited” pace will be appropriate. This is because the MPC still sees excess demand growth, and hence domestic inflationary pressure, emerging over the forecast period.
It is important to note that the MPC’s projections are currently conditioned on the assumption of a smooth Brexit transition. Given the binary nature of the outcome, the Bank of England (BOE) undertook some analysis into the impact on growth and inflation a 5% appreciation or depreciation in sterling, as shown in the table.
Source: Bank of England
It is clear that Brexit uncertainty continues to keep the MPC’s hands tied. But even under a smooth Brexit transition, the BOE’s forecasts imply a one-in-four probability of a UK recession this year. Notwithstanding Brexit developments, given the MPC’s downbeat assessment of UK and global economic activity, we think the bar to a further increase in the Bank Rate is now high.
This article appeared first in Investment Week
Janet Mui, CFA is the global economist at Cazenove Capital, the wealth management division of Schroders. Janet is responsible for the formulation and communication of Cazenove’s top-down views. She is a member of the investment committee that oversees strategic and tactical asset allocation at Cazenove. Janet is also the macro spokesperson and a regular commentator at major media outlets including the BBC, Bloomberg and CNBC.
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