What would a no-deal Brexit do to the economy on top of Covid-19?

Laveta Brigham

EU/UK flags Britain is going through the most profound economic shock in living memory. Shutting down swathes of the economy to battle the pandemic wiped more than one-quarter off GDP by April. The rebound is underway but still far from complete. Into this mighty crunch-and-recovery cycle comes a structural shift: […]

EU/UK flags
EU/UK flags

Britain is going through the most profound economic shock in living memory.

Shutting down swathes of the economy to battle the pandemic wiped more than one-quarter off GDP by April. The rebound is underway but still far from complete.

Into this mighty crunch-and-recovery cycle comes a structural shift: Brexit.

The possibility of ending the transition period without a new deal with the EU appears to be very real.

What would that mean for the economy, and how would these two shocks compare?

A ‘no deal’ Brexit was once seen as the biggest threat facing the economy. That was in an age before Covid. Now, pretty much nothing will register as a big shock on any graph of GDP, because the crash and recovery are quite literally off the charts which were used before this year.

That does not mean any new economic developments are unimportant, however.

The nature of Brexit will affect future growth and determine significant parts of the UK’s future prosperity in the years to come.

Prices

For families, one of the most noticeable impacts might be price rises as imported goods may face more tariffs if no deal is struck.

Supply chains held together remarkably well in the pandemic, with supermarkets in particular being largely successful in keeping the nation fed. Prices rose by just 1pc over the past year, with the fall in prices of globally traded commodities such as oil contributing to the stability of inflation.

Changing taxes at the border, however, is a different matter.

David Potts, chief executive of Morrisons, warned: “Tariffs do drive inflation, so in any year no one wants to see increased prices, particularly not as we are in a recession.”

Samuel Tombs at Pantheon Macroeconomics estimates that the cost of imports overall would rise by around 0.5pc.

Extra customs hassle could cost businesses another £15bn per year.

A fall in the pound from $1.30 today to $1.20 without a deal would push up the cost of imports again. ING analysts think it could even push the pound to parity with the euro.

After three years Tombs estimates overall prices will be around 2pc higher than they would have been without a deal, effectively clipping that amount from families’ living standards.

Investment

Business investment has been hit hard by the pandemic. Companies are focused on staying afloat, borrowing to avoid collapse instead of taking on debt to invest in future growth.

Even as the economy recovers, businesses will remain cautious when they do not know what form Brexit will take, according to Paul Dales at Capital Economics.

“The recent behaviour of the government appears to have increased the chances of something like a no deal Brexit when the transition period ends on December 31,” he said.

“Even if that didn’t materialise, the uncertainty may further crimp business investment in the coming months.

“The recent surge in virus cases, all the talk of tax hikes and the prospect of yet more Brexit uncertainty means the near-term outlook is getting a bit darker.”

GDP

The net effect of this on the economy is always tricky to calculate, and currently next to impossible. At a time when GDP is surging at more than 5pc each month, restrictions are being reimposed, confidence is being alternately boosted by schemes such as ‘eat out to help out’ and trashed by local lockdowns, it is hard to accurately estimate or observe the impact of Brexit uncertainty.

Predictions from the Office for Budget Responsibility and International Monetary Fund last year indicated a no deal Brexit could hit GDP by around 2pc before a recovery kicks in. That sounds small in the context of a Covid crash more than 10-times larger, but is still significant and painful at a time when the country desperately needs to recover.

Brexit Q&A
Brexit Q&A

Mervyn King, the former Governor of the Bank of England, expects the long-term future for the country to be much the same either way.

“I don’t think that, given the scale of restrictions or tariffs that are likely to be imposed, this is a major issue for the UK. We can certainly cope with that without any difficulty,” he recently told the CoronaNomics online series.

Kallum Pickering at Berenberg Bank expects the economy will get back to its pre-Covid size either way, but that a more distant trading relationship with the EU threatens to weaken growth in the longer term.

He predicts a “semi-managed hard exit” in which the UK and EU do not strike a trade deal, but regulators take a pragmatic approach with a “patchwork of measures” to avoid enormous and costly delays for people and goods crossing the borders, and to enable services such as finance to keep flowing smoothly.

As a result the UK should make up the output lost to Covid over the coming years, he said, but could be left with a slower long-term rate of growth thereafter.

Economic Intelligence newsletter SUBSCRIBER (article)
Economic Intelligence newsletter SUBSCRIBER (article)

This smooth transition is not guaranteed, however, and this week’s argument over potential breaches of international law will not help.

“I do worry that by further risking the fragile trust between the UK and the EU with this Internal Market Bill, we are heading towards a situation where we risk that patchwork of measures, which could help manage the exit, being fairly thin,” he said.

“In which case, both sides may not be inclined to be very generous towards each other, which I think would be a very bad outcome.”

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