Published 7/1/19
Published 7/1/19
Reading Min.

A no-deal Brexit probability gains a strong increase following the latest events to date. How would this scenario impact British economy as well as BoE monetary policy in case Boris Johnson becomes Prime Minister?

René Defossez, UK economist and Fixed Income strategist explains you his analysis through this podcast to discover.


HARD BREXIT  - Which impacts to expect according to this scenario?


The strong increase of a no-deal Brexit scenario

There’s a strong increase in the probability of a no-deal Brexit, as shown by the sites of the bookmakers and several market metrics, such as the exchange rate or the breakeven inflation of the British linkers (the only ones to behave well, and who have recently reached quite high levels).
Why this sharp increase?
6 reasons mainly guide us towards this scenario:

  • 1. Theresa May’s repeated failure to secure Parliament’s backing for the Withdrawal Agreement.
  • 2. Theresa May’s resignation, to a large extent a victory for the hard Brexiters in her camp.
  • 3. The Conservative Party’s crushing defeat in the European elections, explained notably by the electors’ exasperation at the government’s inability to deliver Brexit on time.
  • 4. The quite high probability that Boris Johnson will be the next Prime Minister (it is often said that the only person who can prevent Boris Johnson from becoming Britain's next Prime Minister is Boris Johnson itself).
  • 5. The European Union has made it clear it will not renegotiate the Withdrawal Agreement, at best will it agree to rewrite the Political Declaration.
  • 6. The time constraint is not favourable to a renegotiation of the Withdrawal Agreement: the new Prime Minister will take up office at the end of July, after which there will be the summer recess, then the party conferences.

A scenario to expect

Boris Johnson will become Prime minister as he is currently campaigning against Jeremy Hunt. He will try to renegotiate the Withdrawal agreement without conviction, will fail, but he will have prepared the country at the same time for a no-deal Brexit, which will take place on October 31st.
Preparing the country means preparing continuity plans and equivalences accordingly. Actually, the no-deal Brexit will be managed, in order to smooth the shock.

The main risk linked to this scenario is that the Parliament can bring down the government in two different ways either early elections or expecting a vote of no confidence, but the big parties would put themselves at risk with new elections (Brexit Party and Lib Dem could to make a very good score, in spite of the British electoral system which favours the big parties, and which explains the bi-partism in force until today).
On top of that, Boris Johnson could prorogue Parliament as he reminded yesterday, which would equate to a temporary Parliament dissolution, would MPs threaten to bring down the government.
The risk of a new referendum seems weaker.

Impacts on the British economy

Managed or not, the no-deal Brexit will weigh heavily on the British economy, which will fall into recession. In fact, the Brexit risk has already cost the country dearly.

  • 1. Many enterprises had to adjust to this risk with contingency plans that included many resources to be devoted to their preparation. They also had to accumulate stocks on the 1st semester which costs a lot in prevision of Brexit that should had taken place by the end of March initially.
  • 2. One can observe a decrease in investments on a quarterly basis
  • 3. A lack of trust must be considered both in households and within the business community

If we do the math, UK would have already lost up to 55 to 60 billion pound sterling due to Brexit.

A managed no-deal Brexit by the end of October would trigger a decline in GDP for 3 quarters in a row from the last quarter of this year. On a year-on-year basis, it would also mean a GDP decline from Q1 to Q4 next year. And the total loss of wealth compared to a growth trajectory even moderate, let’s say 1.5% per year from now would be an estimate of GBP 130 billion.
Main explanations for the decline in GDP are the following ones: net exports, of course, since the UK has the good idea of creating barriers between itself and the EU, its main trading partner (customs duties, border controls, etc …)
But also, investment, because of the drop in domestic demand and the total uncertainty about the future relations between the UK and the EU (we can still think that the UK will eventually strike a trade deal with the EU).
Consumption will fall with the fall in real wages, the rise in the savings rate or the decline in consumer credit.
Only "good news": the government can use the budget for counter-cyclical purposes, since it has managed to reduce the budget deficit significantly in recent years, at the price of very significant cuts in social spending.
Currency can also be used as a lever for growth, with, of course, the limit of inflation (if inflation increases too much, the FX weapon would become counterproductive).

BOE monetary policy in case of no-deal Brexit

The BoE becomes more nervous with the increasing probability of a no-deal Brexit, as it showed at the last MPC.

The Bank of United Kingdom made impact studies of different scenarios of no-deal Brexit. In the case of a disorderly Brexit, the shock could be more important than the 2008 crisis.
In case of a managed no-deal Brexit, base rate would be back to 0.25%. It should drop quickly, once in December and once in March. The BoE should not use quantitative easing if the decline in GDP is not more violent than what we expect. Quantitative easing is an exceptional tool, but the decline in growth would not be exceptional in its magnitude.

In a nutshell:

1 – We are heading towards a no-deal Brexit, and Boris Johnson would be the future prime minister
2 – The impact on UK economy will be important
3 – As a matter of a fact, the BOE would have to cut its rates