As Russ Mould, investment director at AJ Bell, puts it: “I’m not sure anyone knows quite what the UK will look like after completion of the negotiations, even those who are doing the negotiating.”
The Conservative government has said a deal whereby the UK leaves the single market is their preferred outcome, although whether they will stick to this strategy as the negotiations continue remains to be seen.
The International Monetary Fund has already downgraded its growth predictions for the UK economy this year, to 1.7 per cent from 2 per cent, but even this could be optimistic, argue some as growth in the first half of 2017 has been slow.
It isn’t the case you can easily fall back on WTO rules in the way you might go back to factory settings on a computer because they’re not just sitting there as a default.Stephanie FlandersMichael Baxter, economics commentator for The Share Centre, cautions: "With real wages falling, and likely to carry on falling, political instability and uncertainty over Brexit is likely to have a negative impact on corporate investment, there is a good chance that the second half of this year will only see a modest improvement on the first half.
“Investors shouldn’t be surprised if the IMF downgrades again."
Finding a framework
How the UK economy looks will largely depend on whether any deal at all has been reached by the end of the two-year negotiating period and how much longer discussions continue beyond the deadline.
Mr Mould suggests: “For now, World Trade Organisation (WTO) status looks to be a worst case in Britain’s future dealings with the EU, so that may provide a template for anyone doing a scenario analysis.”
The UK has been a member of the WTO since January 1995, and all EU member states are WTO members. Importantly though, the UK’s membership is tied in with the EU’s at the moment.
The WTO model has been referred to as the framework the UK will rely on should there be no deal in place on 30 March 2019.
But Stephanie Flanders, chief market strategist for Europe at JPMorgan Asset Management, warns there is no such scenario as falling back on WTO status, as even this would have to be negotiated.
“It isn’t the case you can easily fall back on WTO rules in the way you might go back to factory settings on a computer because they’re not just sitting there as a default,” she notes.
“Most of the arrangements through which trade flows through ports and is admitted to be sold in UK shops actually have nothing to do with the WTO, they have to do with boring mutual recognition arrangements that have been negotiated and agreed over decades between countries bilaterally, or as part of the EU and are nothing to do with the WTO.
“I think there is a false confidence that there’s a fall back.”
One of the reasons the WTO model is considered the worst possible outcome for the UK is its tariff structure. Tariffs average around 5 per cent over a broad range of goods, but have important variations, including a near 10 per cent tariff on cars, according to Axa Investment Management.
David Page, senior economist at Axa IM, sets out: “When HM Treasury made its long-term assessment of the impact of Brexit on the economy, it estimated the likely economic cost to the UK in the case of a negotiated bilateral deal to be 4.6-7.8 per cent of GDP.
“However, if the UK adopted a WTO trading relationship with the EU it estimated the cost to rise to 5.4-9.5 per cent of GDP.”
Single market or no single market?
Edward Smith, asset allocation strategist at Rathbones, says the shape of the UK economy after Brexit depends on two things:
- Whether the UK retains any access to the single market programme.
- What happens to the EU project without the UK.
He explains: “If the EU completes the single market – removing the final barriers to trade and investment – then it is much more likely that capital will be reallocated from the UK towards the mainland than if further progress in the EU project stalls.
“If the UK is shut out from the European Single Market and new trade deals are slow to come by, the productivity of the tradeable sectors of the economy, particularly financial services, are likely to undergo a profound period of stagnation.”
He acknowledges both of these outcomes are big ‘ifs’ and even in this worst case scenario the effects will take time to be felt, rather than feeling like an “overnight collapse”.
In a situation where the government’s Brexit committee has not been able to negotiate a deal for the UK by the deadline, is it likely there will be increased market volatility?
“I think long before that it would have become obvious there was not going to be an arrangement and there would be further weakness of the pound but also potentially expectations of quite a lot of economic disruption,” Ms Flanders suggests.
However, she thinks this should not be considered the more likely development.
The only real precedent we have is Greenland’s ‘exit’ in 1985. This was a ‘soft’ exit, but it took three years.Neil Williams“But on the basis of how the early skirmishes have gone with Brussels you can’t rule it out at all. You’d still think there was a chance of that happening that was really too high for comfort, maybe 15-20 per cent,” she adds.
Given how long it has taken the Conservatives and DUP to agree how the coalition government will look does perhaps not bode well for the far more complex process of untangling Britain from the EU.
Best of both worlds
So what is the government aiming for if it does not want to remain in the single market?
Neil Williams, chief economist at Hermes Investment Management, explains: “[Prime minister] Mrs May says no other countries’ membership models will be sought, which seems to rule out Norway and Switzerland’s associate memberships.
“Yet her desire to ‘pursue a bold and ambitious free trade agreement’ with the EU suggests she will negotiate to maintain access to – but no longer full membership of – a tariff-free system (akin to Canada’s deal), and/or a customs union (similar to Turkey’s).”
He observes access to a tariff-free system or customs union could be the best of both worlds but it would still need parliamentary approval.
“Second, the UK is relying on a cooperative sign-off by its 27 EU peers,” he adds. “The only real precedent we have is Greenland’s ‘exit’ in 1985. This was a ‘soft’ exit, but it took three years.
“We, larger and 44 years entwined in the EU, will need longer. Canada’s EU deal last year came after seven years of negotiation, and was toward the end stalled by the Belgian state of Wallonia.”
The government will no doubt be talking up trade negotiations with non-EU nations, with America being the obvious first place to start.Vinay SharmaIt is true most assessments of the UK economy are quick to point out the negative impact.
But the economy may find itself in a position of strength post-Brexit. If that were the case, what might this look like?
Professor Chris Rowley, at Kellogg College at the University of Oxford, asserts any analysis of a post-Brexit economy requires less of the ‘gloom and doom’ type predictions that focus only on the costs and negatives, ignoring the counter-factual and possible benefits.
“Rather it could look like an economy that is better balanced with more exports given more competitive British goods and less reliant on credit and consumer spending, maybe even less reliant on financial services – not a bad thing given the 2008 financial crisis – and dealing more with those more dynamic and faster growing areas of the global economy in Asia,” he notes.
“You never know, it may even ‘jump-start’ the UK economy into a different trajectory and help reduce its over-reliance on cheap labour and the commensurate low investment/innovation/low value-added and ‘sweating the assets’ route to competition – as witnessed by the rise of much of the ‘gig economy’ and zero hour contracts.”
New trade deals
Vinay Sharma, senior trader at Ayondo markets, believes it is far more likely the economy will simply remain stagnant and defy any talk of catastrophe as negotiations are ongoing.
“However, as we eventually exit the EU, which will probably be longer than the two years given, the UK economy will probably be showing signs of decline,” he points out.
“The government will no doubt be talking up trade negotiations with non-EU nations, with America being the obvious first place to start. While these trade deals will no doubt bolster the UK economy, the completion of these deals are likely to take years, and as such, sustainable growth in the UK may be a long way down the road.”
But the UK will have to tread carefully when it comes to setting up new trading deals with countries before it has freed itself entirely from the EU.
As Mr Williams acknowledges: “EU law forbids trade-deal ‘bigamy’, in terms of enacting agreements elsewhere while still an EU member. This prevents a quick compensating tie-up with the US, for example.
“Therefore, a challenge is to remain close to the European negotiating table to maintain the best trade and regulatory deals for services, which account for 80 per cent of the UK’s gross value added. This makes it more ambitious than a Canada-style deal.”
The UK’s attempt to leave the EU is unprecedented, which explains why there is so much uncertainty regarding the prospects for the UK economy in a post-EU membership era.
While it is unsettling, as the talks progress a clearer picture may emerge of the economic outlook.
eleanor.duncan@ft.com
