As businesses assess the possible impact of the new Withdrawal Agreement, Ana Boata, Senior Economist Europe at Euler Hermes’ Economic Research Department in Paris, France, offers her view on the economic impact of the latest Brexit developments.
“In principle” we have a Brexit deal. How is the deal different from Theresa May’s version?
In the previous version of the Withdrawal Agreement, the Northern Ireland backstop would have forced the whole of the UK to remain in the EU customs union in case no alternative solution was found to avoid physical checks on the island of Ireland. The latest deal stipulates that Northern Ireland would be treated differently from the rest of the UK as an entry point to the EU, aligning with the EU’s regulatory arrangements for goods while remaining in the UK’s customs union.
A customs border in the Irish Sea would be set up between Northern Ireland and the rest of the UK and customs declarations on goods sent from Great Britain to Northern Ireland would be needed. Goods imported to Northern Ireland and the Republic of Ireland from other countries (non-EU, including the UK) would either face a UK tariff or the EU’s Common External Tariff, depending on their final destination.
As an example, let’s imagine that a car is imported from the U.S. into Northern Ireland. If this car would stay in Northern Ireland, the UK import tariff would apply (10% if there is no Free Trade Agreement with the U.S. or less in the contrary case); if it is re-exported to the EU, then the EU tariff will apply (10%).
A deal lowers the uncertainty but it will not help the UK avoid a technical recession at the turn of the year and rising business insolvencies in 2020.
Overall, corporates should face lower uncertainty, given that the probability of a no-deal scenario has significantly reduced (to 10% in 2020 from 30% in 2019). We expect the rise in business confidence to boost domestic investment, which contracted over the past two years. Foreign investment should also gain momentum.
Labor shortages should reduce and support corporates’ margins. However, bear in mind the absorption capacity of the precautionary stocks is limited in an environment of low global growth. Consumers have front-loaded their spending, as witnessed by the strong retail sales growth over the past few months, while companies have accumulated high levels of stocks (at a peak since the 2009 crisis). Hence, we expect two quarters of negative growth (-0.1% q/q) in Q4 2019 and Q1 2020.
While the Bank of England is likely to cut interest rates once by year-end (-25bp to 0.5%), this would not be enough to prevent a liquidity risk for some UK companies, which have borne the brunt of the uncertainty and the higher financial costs related to Brexit preparations. Overall, business insolvencies will continue to increase (+5% in 2020 after +11% in 2019). We expect the recovery to only be visible in H2 2020, provided there is political stability, which should allow annual GDP growth to reach +0.8% on average in 2020.
The deal would mean a lower uncertainty cost for Europe too, but we expect EUR2bn less of EU exports to the UK in 2020.
For the EU, Brexit has cost -0.2pp of real GDP growth annually since 2018. Germany was by far the hardest hit, with an export loss of close to EUR8bn since the referendum. The EU managed to compensate for its 2016-18 losses of EUR1.5bn in H1 2019, thanks to UK companies and households’ preparations for a no deal, which brought EUR4.3bn of additional export demand to the EU overall.
The Netherlands, Belgium, Italy and France have benefitted the most from the contingency stockpiling wave in 2019. They should also be those to suffer the most from the negative base effects in the coming months. Overall, EU exports to the UK should fall by EUR2bn in the coming six months and recover thereafter, thanks to the pick-up in domestic growth in the UK.
This article is part of the FERMA/AIRMIC joint Brexit Newsletter which is designed to give risk professionals unique insight into Brexit related risks and mitigation strategies.
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