27/11/2018

UK set for weak GDP growth slowdown as Brexit uncertainty bites

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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. 

Ana Boata, senior economist at Euler Hermes, the world’s leading trade credit insurer, explains that the enduring uncertainty over the UK’s future trading relationship with the EU will continue to weigh heavily on the economy, even if the government secures a last-minute agreement.

Despite the deep political divisions surrounding the draft Brexit deal secured by Theresa May in early November, our central scenario continues to be a last-minute blind deal between the UK and Europe. Though the draft Brexit deal has shown that the UK is full of surprises! We anticipate that the UK and EU will clinch a last-minute agreement by January that will ratify the 21-month transition period. This is expected to take the form of a ‘Blind Brexit’ deal, which will include little detail on the terms of the future trade relationship, with a formal trade accord envisaged for the end of a transition period in December 2020.

Economically, the longer the discussion, the weaker the UK economy, as is visible in the depreciation and volatility of the pound sterling (-10% since early 2016) alongside the rise in inflation and the decline in saving rate of British households. In addition, Brexit related uncertainty has been a significant drag on the attractiveness of the UK for foreign investors, with M&A deals almost two-thirds lower compared to 2016, despite particularly attractive valuations.

Brexit increased uncertainty and has been a drag on both consumer spending and investment decisions in the UK. Hence the rise in insolvencies accelerated (+19% 3m yoy in Q3 2018) as well as the rise in major insolvencies (12 cases in H1 2018 compared to 15 cases in total in 2017).

This increases the negative effects along the supply chain and this is shown in the rise of working capital requirements for corporates. Most of these insolvencies are in the most fragile sectors: those very dependent on foreign inputs which see their margins squeezed as imports are more expensive as well as those highly leveraged as the Bank of England embarked into a monetary policy normalization process with a further rate hike expected in Q2 2019 which will make credit conditions tighter. We expect business insolvencies to increase by another +9% in 2019.

Overall, we calculated that the uncertainty put will cut -0.1pp of growth to the UK every quarter and GDP should grow by a meager 1.2% in 2019.

In the case of a no deal Brexit we expect GDP to contract for two consecutive years with -1% in 2019 due to disruption on the supply chain as custom checks are introduced and tariffs would reach 4-5% on average. Businesses are preparing for the worst through contingency planning and stockpiling, but we believe this would not be enough to mitigate the shock. Business insolvencies would rise by 15% at least in 2019.

Finally, we believe that by 2021, a Norway type of agreement which would allow keeping passporting rights for the financial sector and hopefully avoid any tariffs or custom constraints for trade in goods will be agreed, but intense negotiations are expected and one cannot rule out a longer transition period! This will continue to feed into the uncertainty which has kept UK growth below potential. We estimate UK growth to average 1.5% over the transition period, half of the 2000-07 average for example. 

Euler Hermes is continuously monitoring the various Brexit options closely and assessing the potential impacts for its clients.

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Euler Hermes will be hosting a webinar on 28 November 2018 at 13:00 GMT. 

Ana will share the latest Brexit insights by answering 10 key questions about the future of the UK.

You can register for the event here!