In the event of a no deal on 1 January 2021 (probably announced after mid-November to allow at least one month of preparation), the UK could see a -5% contraction in GDP and a -15% drop in exports, besides inflation beyond 5% for at least six months. This latter will mainly be driven by the strong rise in import prices (+15%) on the back of: (i) higher average import tariffs on total imports (+1pp to 2.6% ); (ii) a significant rise in non-tariff barriers (supply-chain disruption, administrative hurdles, increased transportation costs and time) — estimates  suggest these could act as a +10% ad-valorem tariff on product value for imports coming from countries such as France, Germany or Spain, as they are part of the Customs Union and the Single Market, and around +5% on imports coming from Norway, a member of the Single Market but not the Customs Union. (iii) a forecasted -10% depreciation of the sterling.

Import prices will rise the most for the following categories (i) footwear, headgear, umbrellas, whips, riding-crops, feathers, artificial flowers (+21%), (ii) textile materials (+21%), (iii) animal products and live animals (+20%), and (iv) food and beverages (+20%). Depending on the nature of imports, their sensitivity to changes in prices varies – in general, we expect a higher elasticity on second necessity goods such as high-tech products, machinery and equipment, automotive etc. 

Taking into account the rise in import prices as well as the import sensitivity to prices (on average 0.4), we calculate that Germany could lose as much as EUR8.2bn of its exports to the UK in value (11.2% of its exports to the UK and 0.6% of its total exports). The Netherlands will see its exports decrease by EUR4.8bn (10.5% of its exports to the UK) and France by EUR3.6bn (11%) – for the most exposed European countries and products. 

We expect the authorities to step in in the case of a Hard Brexit. The BoE would significantly ease the stance of its monetary policy. Key interest rates are expected to go into negative territory and QE to be increased by GBP250-300bn, similar to the Covid-19 package, and at least double compared to our baseline scenario. On the fiscal side we expect 4% of GDP in additional measures in 2021 (against 2% in the baseline scenario), with a focus on infrastructure spending, protection of consumers’ purchasing power (prolonged VAT rate cut and consumption vouchers) and liquidity measures for companies.