Brexit deal or no deal gulf narrows - Capital Economics
UK Economics

Brexit deal or no deal gulf narrows

UK Economics Weekly
Written by Andrew Wishart

UK-EU relations deteriorated on one front this week, with the EU starting legal proceedings over the UK’s plans to undermine parts of the Withdrawal Agreement, but improved on another as negotiations on the future trade deal made progress. But with lots of arrangements already in place, no deal may not be as bad for the economy as most fear. That’s unless relations between the UK and EU break down completely, in which case it would be more disruptive.

While UK-EU relations deteriorated on one front this week, with the EU sending the UK a letter to formally begin legal procedures over the UK’s plans to undermine parts of the Withdrawal Agreement, there appears to have been a more constructive mood in the negotiations on the future trade agreement. There has been no official read out, but before this week’s ninth round of negotiations four of the 11 areas in the agreement were sticking points. Media reports suggest that this may have been reduced to just one; state aid.

As we highlighted in the Focus we published this week, a one-stop shop for all you need to know about Brexit, the gulf between a deal and no deal has shrunk. (See here.) That’s because a lot of arrangements are already in place. Indeed, in a “cooperative” no deal where the EU and UK try to smooth the impact, the fallout would be limited. Trade deals with non-EU countries have been replicated, firms have had time to prepare, several agreements are already in place, and temporary unilateral measures would ease the disruption.

That said, if it turns out that the EU’s letter marked the start of a complete breakdown in relations, there could be an “uncooperative” no deal where existing agreements unravel and the onerous application of new customs rules disrupts trade. Even in an “uncooperative” no deal, we suspect that the disruption would be short-lived. And the economic fallout from any no deal will be small compared to the pandemic. (See Chart 1.)

Chart 1: GDP (Q4 2019 = 100)

Sources: Refinitiv, Capital Economics

Even before then, aside from another batch of solid data on the housing market (see here), it looks like the strong initial recovery is petering out. After a 6.6% m/m gain in July, our BICS indicator points to a 5% m/m rise in GDP in August and a 2% m/m increase in September. That’s all before new restrictions were imposed in late September. And with virus cases still rising, it looks more likely that the restrictions will be tightened than loosened. We expect GDP to stagnate for the remainder of the year, some 5.5% below its pre-virus level. (See here.)

The Bank of England will surely respond. But it can’t get its message straight on negative interest rates. This week MPC member Silvana Tenreyro said the evidence on the use of negative rates elsewhere is encouraging. But Dave Ramsden and Andy Haldane are unconvinced that “the balance of costs and benefits from using this tool [are] positive.” Their thinking is that the hit to bank profitability combined with loan losses could lead banks to reduce lending. In any case, the Bank won’t have a system in place to implement negative rates for several months. As we set out here, here and here, we think QE will remain the tool of choice. Investors were probably right to unwind the negative rates bets they put on after the September MPC minutes. (See Chart 2.)

Chart 2: Expected Bank Rate Implied by OIS Rates (%)

Sources: Refinitiv, Capital Economics

The week ahead

The release of August GDP data on Friday will be the last good one for a while. More Brexit negotiations may be scheduled ahead of the European Council leaders’ summit of on 15/16th October.


Data Previews

Monthly GDP & Services Output (Aug.) Fri. 9th Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Monthly GDP m/m(y/y)

07.00

+6.6%(-11.7%)

+5.0%(-7.2%)

+5.0%(-7.2%)

Services Output m/m(y/y)

07.00

+6.1%(-12.4%)

+4.8%(-8.2%)

+5.5%(-7.6%)

The last of the big gains

Our estimate that GDP rose by around 5.0% m/m in August would mean that it was about 7.5% below its pre-crisis level in that month.

Our CE BICS Indicator, which we derive from an ONS fortnightly survey on business turnover (see here), suggests that the 6.6% m/m jump in GDP in July was followed by another rapid gain of around 5.0% m/m in August. (See Chart 3.) That may have been due to a 5.5% gain in services output, as output in the accommodation and food services sector received a boost from the Eat Out to Help Out restaurant discount scheme, a 5.0% m/m gain in construction output and a more modest 1.5% m/m rise in industrial production (see the preview below). But there is evidence that the economic recovery is now slowing. The CE BICS Indictor implies that GDP rose by a smaller 2.0% m/m in September. And we think that the renewed COVID-19 restrictions and Brexit uncertainty will mean that GDP stagnates in Q4, leaving activity 5.5% short of pre-virus levels.

Chart 3: CE BICS Indicator & GDP

Sources: Refinitiv, ONS, Capital Economics

Industrial Production (Aug.) Fri. 9th Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Manufacturing Output m/m(y/y)

07.00

+6.3%(-9.4%)

+2.9%(-5.4%)

+2.0%(-6.8%)

Industrial Production m/m(y/y)

07.00

+5.2%(-7.8%)

+2.5%(-3.9%)

+1.5%(-5.5%)

Industry to keep recovering as services stagnate

The recovery in industry probably slowed further in August, but this is mainly because the sector has already regained most of the losses endured during the pandemic.

Manufacturing has staged a rapid comeback growing by 6.3% m/m in July and is now just 6.9% below its pre-crisis level. Despite the IHS Markit/CIPS manufacturing PMI peaking at 55.2 in August, up from 53.3 in July, the recovery in output probably slowed sharply. Indeed, seasonally adjusted car production fell by 24.1% m/m in August, which will partially offset growth elsewhere. (See Chart 4.) As a result, we are only expecting a 2.0% m/m rise in manufacturing output. Meanwhile, electricity and gas usage data suggest that utilities output fell slightly in August and oil production probably did not grow by much as it was already almost at its pre-virus level in July.

Overall, industrial production probably rose by about 1.5% m/m in August, which would leave it about 5% below its pre-virus level. Looking forward, the industry is less likely to be affected by the new COVID-19 restrictions than services, so the manufacturing sector might continue to recover while the rest of the economy stalls.

Chart 4: SMMT & ONS Car Production

Sources: Refinitiv, Capital Economics

International Trade (Aug.) Fri. 9th Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Trade in Goods & Services Balance

07.00

+£1.1bn

£0.0bn

Trade surplus eliminated as recovery in imports continues

As imports continued to recover from their steeper fall than exports in the first half of the year, the unusual trade surplus the UK has had for much of the past year was probably eliminated in August.

Trade was already weak due to a hangover from stockpiling in case the UK left the EU without a deal on 31st January 2020 before plunging in March and April as national lockdowns caused many businesses to cease operations.

But while exports and imports have since recovered, by July they were still 14% and 19% below their 2019 levels respectively. (See Chart 5.)

Survey measures of export orders have continued to recover in September. The export orders balance of the manufacturing PMI rose from 47.7 in July to 51.5 in August after hitting a trough of 25.2 in April. But the impressive rebound in consumer spending, of which about a fifth is imported, suggests that the rise in imports will be larger.

We have pencilled in a +7.0% m/m increase in imports and a +4.5% m/m rise in exports in August which would cause the trade balance to shift from a surplus of £1.1bn in July into balance (£0.0bn). The elimination of the trade surplus will mean net trade is a drag on GDP in Q3, perhaps to the tune of 1.0ppts. But that will only make a small dent in the recovery in the economy overall.

Chart 5: Trade Values (£bn)

Sources: Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 5th

UK

IHS Markit/CIPS Services PMI (Sep, Final)

(09.30)

55.1p

55.1

54.5

DR

 

UK

IHS Markit/CIPS Composite PMI (Sep, Final)

(09.30)

55.7p

55.7

55.5

DR

 

UK

MPC’s Haldane speaks on modelling

(09.30)

Tue 6th

UK

IHS Markit/CIPS All-Sector PMI (Sep)

(09.30)

58.7

55.0

DR

 

UK

IHS Markit/CIPS Construction PMI (Sep)

(09.30)

54.6

54.6

Wed 7th

UK

House Price Index (Jul)

(09.30)

+0.2%(+3.4%)

(+3.2%)

(+3.5)

 

UK

Unit Labour Costs (Q2)

(09.30)

+3.3%(+6.2%)

 

UK

Productivity (Q2, Prov.)

(09.30)

-0.3%(-0.6%)

 

UK

Michael Gove interviewed by Brexit Committee

(16.30)

Thu 8th

UK

RICS Past House Price Balance (Sep)

(00.01)

+44%

+38%

+48%

Fri 9th

UK

GDP (Aug)

(07.00)

+6.6%(-11.7%)

+5.0%(-7.2%)

+5.0%(-7.2%)

DR

 

UK

Service Output (Aug)

(07.00)

+6.1%(-12.4%)

+4.8%(-8.2%)

+5.5%(-7.6%)

DR

 

UK

Industrial Production (Aug)

(07.00)

+5.2%(-7.8%)

+2.5%(-3.9%)

+1.5%(-5.5%)

DR

 

UK

Construction Output (Aug)

(07.00)

+17.6%(-12.7%)

+3.7%(-10.9%)

+5.0%(-8.3%)

DR

 

UK

Manufacturing Output (Aug)

(07.00)

+6.3%(-9.4%)

+2.9%(-5.4%)

+2.0%(-6.8%)

DR

 

UK

International Trade Balance (Aug)

(07.00)

+£1.1bn

£0.0bn

DR

 

UK

International Trade in Goods Balance (Aug)

(07.00)

-£8.6bn

-£9.0bn

-£9.1bn

DR

 

UK

MPC’s Haldane speaks at OECD conference

(16.15)

Selected future data releases and events

Tue 13th

UK

Labour Market (Aug/Sep)

(07.00)

DR

Thu 15th – Fri 16th

UK

European Council Summit

*m/m(y/y) unless otherwise stated, p provisional flash estimate

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts*

%q/q(%y/y) unless stated

Latest

Q1 2020

Q2 2020

Q3 2020

Q4 2020

2019

2020

2021

2022

GDP

-19.8(-21.8) (Q2)

-2.5(-2.1)

-19.8(-21.5)

+18.0(-7.7)

+3.0(-5.0)

(+1.3)

(-9.0)

(+7.0)

(+3.3)

CPI inflation

(+0.5) (Aug.)

(+1.7)

(+0.6)

(+0.6)

(+0.6)

(+1.8)

(+0.9)

(+1.3)

(+1.7)

ILO unemployment rate (%)

3.9 (June)

3.9

3.9

5.2

6.2

3.8

4.8

6.5

6.1

Bank rate, end period (%)

0.10

0.10

0.10

0.10

0.10

0.75

0.10

0.10

0.10

10 yr gilt, end period (%)

0.23

0.36

0.17

0.23

0.15

0.83

0.15

0.15

0.15

$/£, end period

1.29

1.24

1.25

1.29

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.10

1.14

1.11

1.10

1.13

1.18

1.13

1.13

1.13

Sources: Capital Economics, Refinitiv

* Assumes the UK and the EU agree a slim trade in goods deal by the end of the year, with the status quo for services and financial services maintained until a later date. (See here.)


Andrew Wishart, UK Economist, +44 7427 682 411, andrew.wishart@capitaleconomics.com