The Chief Economist’s Note

A very British farce

I have been loath to wade into the debate around Brexit in these notes. That’s partly because it has become a sorry and depressing tale of abject political failure on pretty much every side in the UK. But it’s also because (so far at least) the UK economy appears to have shrugged off the latest twists, turns and general descent into farce.

According to the latest official estimates of monthly GDP that were released last week, the UK economy grew by 0.2% m/m in February. This pushed the rolling quarterly growth rate up to 0.3%. Admittedly, quarterly growth has slowed from the average rate of 0.4% recorded in 2017 and 2018. But that slowdown needs to be viewed in the context of weakness elsewhere in the global economy. The UK economy appears to have grown at a similar pace to the US in Q1 of this year, and is likely to have outperformed the euro-zone. (See Chart.)

Chart: GDP Growth (% q/q, SA)

GDP Growth (% q/q, SA)

Viewed over a longer horizon, Brexit has had an impact on UK growth. In the initial aftermath of the Brexit vote, the sharp fall in the pound pushed up inflation, which in turn weighed on consumer spending. The squeeze on consumers has since faded, only to be replaced by signs that uncertainty over Brexit has begun to weigh on business investment. All told, we estimate that the combined effect so far Brexit has pulled down UK GDP by around 1.5-2.0% relative to its pre-referendum baseline.

However, while that’s not insignificant, it’s worth noting that it is dwarfed by the hit to GDP caused by previous economic and financial shocks. For example, had the UK economy continued to grow at its trend prior to the 2008 financial crisis it would now be 20% larger than it is today.

Looking ahead, assuming that “no deal” is now off the table, I see two Brexit-related threats to the UK economy. The first stems from the UK’s large current account deficit. It stood at 4.4% of GDP in Q4 of 2018, which, were it an emerging market, would put the UK in the danger zone. (Turkey and Argentina have recently experienced balance of payments crises having run current account deficits or around 5-6% of GDP.)

The UK, is not (at least yet) an emerging market and there are several reasons why it is less vulnerable to the same “sudden stop” in external financing that caused problems in Turkey and Argentina. But the current account deficit does pose risks in other ways. For example, if uncertainty over Brexit persists – or is resolved by a general election and subsequent shift towards less market-friendly policies under a Corbyn-led government – then a weaker pound may be required to sustain the UK’s balance of payments position. This may in time help to narrow the current account deficit, but the immediate effect would be to squeeze consumer spending.

The second threat to the economy stems from continued kicking of the Brexit can down an ever-lengthening road. I noted earlier that uncertainty over Brexit appears to be weighing on business investment. This dampens demand (and thus GDP growth) in the short-term. But it also affects the UK’s capital stock and thus long-run growth prospects.

As it happens, long-run growth in the UK will be shaped by a multitude of different factors, the most important of which may not be Brexit but instead whether the development of digital technologies ultimately deliver productivity benefits. But even so, continued delay and prevarication over Brexit will produce economic costs in the form of delayed or deferred investment that will compound over time. In this sense, while kicking the can down the road helps avoid the immediate and significant disruption that would occur under a “no deal” Brexit, the potential for it to cause economic damage over the medium-to-long run may be underappreciated.

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