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Brexit uncertainty to drive UK economy to recession

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Brexit uncertainty will slash UK economic growth in 2019 to the weakest rate since the global financial crisis a decade ago even if the UK manages to secure an orderly departure from the European Union next month, according to the Bank of England’s latest forecasts. The central bank now expects growth in 2019 to come in at only 1.2 per cent, driven by slumping business investment as firms freeze spending due to the heightened risk of a no-deal outcome on 29 March.

That forecast in the Bank’s latest Inflation Report is down sharply from the 1.7 per cent growth it estimated in November and would be the feeblest performance since GDP plummeted by 1.4 per cent in 2009. It also sees a roughly one in four probability of a recession in the second half of 2019. This slowdown mainly reflects softer activity abroad and the greater effects from Brexit uncertainties at home, said the Bank, admitting that business investment had been considerably weaker than it previously anticipated due to fears over a Brexit cliff-edge for trade. Yet the Bank stressed that even this much weaker outlook was conditioned on a “smooth adjustment” to life outside the EU. Last December it published stress test scenario for banks in which a no-deal Brexit could plunge Britain into the worst recession since the 1920s, with GDP collapsing by 8 per cent.

In November the Bank had expected business investment to grow by 2 per cent in 2019. Now it expects a fall of 2.75 per cent. Its 2020 forecast is also slashed from 5 per cent to 2.75 per cent. As expected by markets, the Bank’s Monetary Policy Committee (MPC) voted to keep interest rates unchanged at 0.75 per cent. The markets are currently pricing in no rate hike until the middle of 2020. 

In December they had priced in one quarter point increase in 2019 and another in 2020. With the Bank’s inflation forecast broadly unchanged by the end of the forecast period from November, anticipated at 2.1 per cent in Q1 2021, markets are likely to take the latest inflation projections as a signal that the MPC is in no hurry to raise rates.

The Bank’s 2020 GDP growth rate is also reduced to 1.5 per cent, down from 1.7 per cent previously, although it has pencilled in a recovery to 1.9 per cent in 2021 if Brexit is smooth and the UK is safely in the transition period. Emphasising how much damage Brexit has already done to business investment, which accounts for around 10 per cent of UK GDP, the Bank noted that the post-2008 recovery in firms’ spending had “stalled” since the 2015 referendum act was passed. The Bank also published some modelling which suggests that if uncertainty fell and financial conditions across the economy improved UK GDP growth could be lifted to 1.6 per cent this year and 2.2 per cent in 2020.

The latest report from the Bank’s network of regional agents relates that around half of the 200 firms questioned said they are “not ready” for a no-deal Brexit, even though most had a contingency plan in place. In the near term, the Bank expects growth in the final quarter of 2018 to have been 0.3 per cent and to decline to 0.2 per cent in the first quarter of 2019. This opens around a small amount of slack (0.25 per cent of GDP) in the economy according to the Bank.

The Bank re-iterated its warning that, in the wake of no-deal Brexit, interest rates could move in either direction, depending on MPC estimates of the extent of damage to demand and supply, although many analysts think that the Bank would be more likely to cut rates to support spending in such circumstances.

The economic outlook will continue to depend significantly on the nature of the EU withdrawal,” said the Bank. “In particular: the new trading arrangements between the European Union and the United Kingdom, whether the transition to them is abrupt or smooth, and how households, businesses and financial markets respond.

Posted by MMB Finance Swindon and Gloucester on 8 February 2019