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With less than a month to go until the scheduled Brexit date of 29th March 2019, the conditions under which the UK will exit the EU remain highly uncertain. The options range from leaving the EU without a deal, to staying in the EU. The UK’s decision to leave the EU has already taken a toll on the UK economy, but the size of final economic cost of Brexit will heavily depend on the shape of the exit.
After a preliminary EU-UK deal was reached in November 2018, it was defeated in the British Parliament on January 15th by the largest votes margin since 1924. The November UK-EU deal is roughly the only one compatible with avoiding a hard border between the Republic of Ireland and Northern Ireland, avoiding significant internal trade barriers between Northern Ireland and the rest of the UK and regaining control of UK immigration policy (perhaps the main practical objective of leaving the EU). Its rejection emphasizes the enormous divide between Brexiteers and pro-EU Remainers in British politics.
Brexiteers mostly would opt for exiting the EU without a deal by now. Remainers are pushing for a second referendum in hopes of reversing Brexit, or for a Norway Plus deal that would leave the UK in the European Single Market (ESM) and Customs Union (CU) while abandoning the attempt to restrict immigration.
|Disorderly ND Brexit||7|
Source: Euromonitor International Macro Model
The likelihood of a Light/No Brexit outcome has increased to close to 40% at the end of February, with the likelihood of leaving without a deal declining to around 20%. This follows several moves pushing towards a lighter Brexit in recent weeks. British Prime Minister May has announced that if her deal is rejected on March 12th, Parliament will get to vote on exiting without a deal and on an extension of article 50. Furthermore, the Labour party is set to propose a 2nd Brexit referendum, now that their own Brexit deal proposal has been rejected in parliament. This has slightly increased the odds of the UK remaining in the EU. The likelihood of PM May passing her deal have also increased to around 40%, due to growing pressure on Conservative Brexiteers to accept it and avoid an extension of article 50 that could lead to a much lighter Brexit or no Brexit.
In our baseline forecast, the EU and the UK continue negotiating a final relationship in 2019-2020, using the framework of the November 2018 deal. The UK remains a member of the European Single Market during the transition, but it continues to pay EU contributions while losing any voting rights at the EU. A Customs Union (CU) agreement is likely to be reached in 2020, either under the current Conservative British government or with a new Labour government following elections.
The CU maintains tariff-free trade in goods between the EU and UK. It avoids a hard border between the Republic of Ireland and Northern Ireland, while maintaining an almost frictionless flow of goods, services and people between Northern Ireland and the rest of the UK. However, the CU leads to significant non-tariff barriers, especially for services. The UK loses its financial services EU passport. UK annual real GDP growth in 2019-2020 is expected at around 1.4%, followed by annual GDP growth of 1.6% in 2021-2025. We assign the baseline scenario a 37-47% probability, roughly around 42%.
Pro-EU factions may still prevail in the British Parliament, leading to the UK targeting a final deal close to Norway’s European Economic Area conditions together with a Customs Union (Norway Plus). Alternatively, the UK holds a second referendum between negotiating a final deal based on the November 2018 UK-EU agreement and staying in the EU. Current polls suggest the Remain side would win a second referendum by a small margin.
In this scenario, the UK retains access to the European Single Market, Customs Union and financial sector passporting rights. UK citizens also retain full EU movement and immigration rights. In exchange, the UK allows free movement of EU citizens. Business investment recovers from the slow growth in 2016-2018 and consumer spending rebounds. Real GDP growth recovers to around 2% annually in 2019-2020. The level of GDP increases by 1-3% relative to the baseline forecast over 2019-2023.
We assign the Light Brexit scenario a 33-43% probability, roughly 38%. Among the Light Brexit options, we see a complete Brexit reversal as less likely. Recent votes have shown there is significant pressure on Labour MP’s from pro-Leave constituencies against holding a second referendum, counterbalancing any support for this option from Conservative Remainers. As a result, Parliament would likely reject a second referendum in a vote.
In the No-Deal scenarios, negotiations between the EU and the UK break down after the British Parliament rejects the November 2018 Brexit deal, and the UK leaves the EU at the end of March 2019 without reaching a trade agreement. Trade relations with the EU default to World Trade Organization (WTO) conditions. This is the default option if the British Parliament does not approve the deal proposed by PM May, and the process 50 for leaving the EU is not reversed or extended. Overall, we see a 15-25% probability of the UK exiting the EU without a deal, i.e. roughly 1/5.
In our main No-Deal scenario, severe trade disruptions last for 1-2 quarters, until UK and EU customs services develop the capacity to handle the massive increase in work volume and complexity. Supply chain disruptions lead to slowdowns in factory production lines. Pessimism about future profits reduces business investment and labour demand. Consumer spending also declines due to lower wages, higher inflation, higher unemployment and reduced future income prospects. GDP growth declines to 0.8% in 2019 and 0.4% in 2020. Declines in trade and foreign investment reduce long-term labour productivity. The level of UK GDP declines by 2-5% below the baseline forecast in 2019-2023. We assign this scenario a 10-15% probability.
In a more severe Disorderly No-Deal scenario, border disruptions last for 2-4 quarters, trade responsiveness to higher tariffs and non-tariff barriers is stronger than expected and the British economy is hit by significant financial shocks after exiting the EU without deal. In this case, the UK economy would enter a severe recession, with GDP contracting by around 1.9% in 2019 and 2.1% in 2020. UK real GDP declines by 5-9% below the baseline forecast in 2019-2023.We assign the Disorderly No-Deal scenario a 5-10% probability.
For more detailed Brexit analysis, Euromonitor International’s Brexit Scenarios Tool examines the impact of different Brexit scenarios on our baseline forecasts for the UK economy, industries and consumers. It offers a range of outcomes, helping businesses to stress-test strategy, plan and remain profitable in these challenging times.