The Taming of the Brexit

The UK economy will continue to be resilient during the negotiations period but consumer spending would take a hit from higher inflation and slowdown in wages, and investments could go into wait-and-see mode. Overall, we expect UK GDP growth to slow down to +1.4% in 2017 from +1.8% in 2016 and to +1.0% in 2018.

The two-year timeframe is not realistic to agree on both the exit deal and the trade deal. We thus expect both parties to adopt a transition deal (80% probability) covering EU-UK relations to bridge the gap between the end of Brexit negotiations and the final Free Trade Agreement (FTA). A final deal could come in 2021 after the H1 2020 general election. Our baseline scenario is a Limited FTA where selective sectors would be duty-free while others would be subject to tariffs. Annual GDP growth should slow down to +0.3% in 2021.

In the UK, impacts would be visible on households, companies, markets and policymaking.

Outside of the UK, investors and exporters doing business in the UK will be negatively affected through the currency depreciation (-5% on average), slowing domestic demand and the rise in insolvencies (+5% in 2017 and +6% in 2018). Looking at trade and investment relationships, the EU countries which are expected to be most affected are: the Netherlands (-1.8pp of GDP growth cumulative 2017-21 in the baseline scenario), Ireland (-1.2pp) and Belgium (-1.0pp). Overall, we expect a moderate impact on eurozone GDP (-0.4pp).

The loss in attractiveness of the City of London could benefit Luxembourg, Ireland, the Netherlands, and Germany, in that order.

Note that a cliff-edge scenario is still possible yet very unlikely (20% probability). It could come from either a lack of a transition deal in 2019 or a final extreme World Trade Organization-like status in 2021. In both cases, disruption in trade flows will have a significant negative impact on the UK and the EU. Overall, GDP would fall by -1.2% in 2019, and remain in recession until 2021. For UK exporters, losses could amount to GBP30bn for goods and GBP36bn for services. For the rest of the world, 2019 could be a particularly costly year for exporters in Germany (~EUR8bn), the Netherlands (~EUR4bn), and France (~EUR3bn), as the pound loses another 20% and tariffs apply.

In the long run, even with a limited FTA agreement, Brexit does mean a GDP growth average of 1.3% for the UK, below its pre-Brexit average of close to 2%. Stronger yet one-sided trade, monetary or fiscal policy boosts would have only limited positive effects.