Pick your own Brexit forecast - Capital Economics
UK Economics

Pick your own Brexit forecast

UK Economics Update
Written by Ruth Gregory

As long-term clients will know, we have been publishing different forecasts for the economy based on two different Brexit outcomes, “deal on 31st October” and “no deal on 31st October”. We are now adding a third – “repeated delays” in which the Brexit can is kicked down an ever-lengthening road. If a common theme across these three scenarios emerges, though, it is that fiscal policy is set to loosen. And with the economy close to capacity, that points to higher interest rates than might otherwise have been the case.

  • As long-term clients will know, we have been publishing different forecasts for the economy based on two different Brexit outcomes, “deal on 31st October” and “no deal on 31st October”. We are now adding a third – “repeated delays” in which the Brexit can is kicked down an ever-lengthening road. If a common theme across these three scenarios emerges, though, it is that fiscal policy is set to loosen. And with the economy close to capacity, that points to higher interest rates than might otherwise have been the case.
  • Plenty of ink has been spilt exploring the ways in which Brexit will play out. The purpose of this Update is not to hazard a guess as to what will happen next, but to consider the consequences of the main possible outcomes. For the purposes of clarity and to cover all bases, we are now publishing forecasts for the economy and the financial markets based on three Brexit outcomes. (The forecasts in each scenario are in Table 1.)
  • Scenario: “Deal on 31st October”. With both Jeremy Hunt and Boris Johnson promising to return to Brussels to renegotiate the Withdrawal Agreement, a fudge on the Irish backstop and a deal by 31st October isn’t entirely out of the question. That would allow sterling to rally, the economy to bounce back in 2020 as uncertainty recedes and would put a rate hike on the agenda for next year.
  • Admittedly, we would expect only some of the economic activity that has been put off to come back on stream. (See our UK Economics Update “What next for business investment”, 18th March 2019.) Quarterly GDP growth would accelerate to perhaps 0.6% q/q or so in the second half of 2020, leaving growth in the year as a whole at around 1.7%, rising to 2.2% in 2021. (See Chart 1.) The middle to end of 2020 would be the most likely timing for a rate rise.
  • Scenario: “No deal on 31st October”. If a deal isn’t agreed both Boris Johnson and Jeremy Hunt have said that they would go for a no deal on 31st October. Plenty has been written about the economic effects of a no deal Brexit. But a big misconception is that there is only one form of no deal. In reality, it is not that clear cut and depends on what happens on things like no deal preparations, tariffs, the policy response and UK/EU relations. Chart 2 illustrates this by showing a range of plausible outcomes. No further preparations, full WTO tariffs, no policy response and a bad breakup might leave growth towards the bottom of that range. But the opposite could leave it towards the top.
  • While we cannot stress the uncertainty enough, for what it’s worth, the blue line is our best guess. Indeed, recent communications from Bank of England Governor Mark Carney have supported our view that Bank Rate would be cut quickly, perhaps from 0.75% now to 0.25%. (See UK Economics Update, “What would happen if there was a no deal Brexit?”, 9th April 2019.) What’s more, a sizeable fiscal policy response, a decision by the UK to unilaterally reduce import tariffs (see UK Economics Update “No easy choice on no deal tariffs”, 26th February 2019) and the no deal preparations that are already in place on things like financial services and aviation, should mean that the economic damage of a no deal Brexit is less severe than many have warned. And if growth rebounds to 2.2% in 2021, as we expect, that could lead to a rise in rates again in that year.
  • Scenario: “Repeated delays”. A no deal outcome may not be the foregone conclusion that some think it is – even under a new Prime Minister who has promised to leave the EU on 31st October come what may. Parliament could prevent it by putting legislation in place, or by triggering a no confidence vote in the Government. There is still the possibility too of a delay to allow time for a second referendum.
  • That leaves us with our new “middle” scenario of continued kicking of the Brexit can down an ever-lengthening road. It assumes that Brexit is delayed again and again at least until the end of 2021, either in a series of short delays or one long delay. If a no deal is averted a number of times, this might lead to some recovery in business investment – although not as much as in our deal scenario, limiting the extent of any rebound in the economy and sterling. (See Chart 1 again.) Clearly, much depends on the length of any delay. But if the delay is lengthy, then we expect Bank Rate to rise anyway, perhaps reaching 1.25% by the end of 2021. (See Table 1 again.)
  • Stepping back from the Brexit chaos though, there are two common themes. First, regardless of the political situation, the fiscal tide is turning. Both Conservative leadership candidates have been falling over themselves to announce bigger and wider ranging tax cuts and spending rises, whether there is a Brexit deal or not. Admittedly, when it comes to actually hammering out policy and paying for it, the candidates’ ambitions might quickly become curtailed. But with the economy already close to capacity, any fiscal stimulus is likely to boost inflation too. The implication is that this will probably require the Bank of England to raise interest rates by more than might otherwise be the case.
  • Second, 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 medium-term economic damage may be underappreciated. In our “repeated delays” scenario, the UK is consigned to at least another two years of sub-standard growth of around 1.5% and while some activity might return, we would not expect much in the way of a bounce back until a resolution on Brexit is found. If anything, the lack of progress on Brexit might even mean that the Bank of England barely raises rates at all.
  • Overall, it is important to note that none of these three scenarios should be considered our central forecast. Where we have to provide one forecast, we’ll provide the “repeated delays” one simply because it is in the middle – not necessarily because we think it is the most likely. Instead, the scenarios are designed to be like an economic pick n mix – clients can choose which Brexit outcome they think is the most likely and use that scenario to guide them.

Chart 1: GDP (% y/y)

Chart 2: GDP in Different No Deal Outcomes (% y/y)

Sources: Refinitiv, BoE

Sources: Refinitiv, Capital Economics

Table 1: Capital Economics Forecasts Based on Various Brexit Outcomes

Deal by 31st October

Repeated Delays

No deal on 31st October

2019

2020

2021

2019

2020

2021

2019

2020

2021

GDP (% y/y)

1.5

1.7

2.2

1.5

1.5

2.0

1.3

0.5

2.2

Bank Rate* (%)

0.75

1.00

1.50

0.75

1.00

1.25

0.50

0.25

0.50

$/£*

1.25

1.35

1.40

1.25

1.30

1.35

1.15

1.20

1.25

10 Year Yield* (%)

1.00

1.50

2.00

1.00

1.25

1.75

0.75

0.75

1.25

*End-period; Source: Capital Economics


Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com