Risk of a “cooperative” no deal Brexit rises - Capital Economics
UK Markets

Risk of a “cooperative” no deal Brexit rises

UK Economics Weekly
Written by Ruth Gregory

It’s been over four years since the EU referendum and the world is a clearly a very different place. However, when it comes to Brexit, it feels like Groundhog Day. The EU Summit on 10th/11th December, billed as the moment when a Brexit deal could be agreed, has come and gone. And the only real decision the PM and Ursula von der Leyen made this week is that they are not ready to make a decision. Instead, the new decision “deadline” is Sunday 13th December.

With the stalemate dragging on, the risk of a no deal seems to be increasing all the time. The PM warned on Thursday that a no deal is now a “strong possibility”. Ursula von der Leyen too suggested that no deal is now more likely than a deal.

So while only a few weeks ago we thought that the odds were a bit greater than our published probabilities of 60:40 in favour of a deal, we now put the chances at 50:50. And even that may be a bit generous. It is perhaps no surprise, then, that sterling has dropped to a three-month low of €1.09 against the euro, slipped to a one-month low of $1.32 against the dollar. And investors have rushed to hedge themselves against a fall in sterling.

At least if there is a no deal Brexit, there are two reasons why a “cooperative” one (in which all the side deals currently in place remain) seems more likely than an “uncooperative” one (in which the agreements already in place unravel and few measures are applied to mitigate the disruption on 1st January).

First, a lot of arrangements are now in place. As the Bank of England put it in its Financial Policy Summary today, “most of the risks to UK financial stability…have been mitigated”. And the UK has replicated over 75% of the trade deals it had with non-EU countries via the EU. What’s more, in its contingency measures published this week, the European Commission put forward proposals to mitigate disruption to air and road travel in the event of a no deal, for six months after 1st January.

Second, the UK government’s decision to remove the clauses from the Internal Market Bill, which would have overwritten some aspects of the Withdrawal Agreement, suggests that there is now a smaller chance of an unravelling of the agreements already in place. (See here.)

So this is clearly not the kind of disruptive no deal exit from the EU that was widely spoken about after the Referendum in June 2016 and just before the original Brexit deadline of 29th March 2019. In fact, if there were a “cooperative” no deal Brexit, we think that GDP in 2021 would now only be 1.0% lower than if there were a deal. (See here.)

That said, we do not think it is game over for a Brexit deal yet. Sunday’s decision could prove to be the turning point that results in the UK and EU hurtling either towards an agreement or a no deal. Equally, if the past is anything to go by, we may not find out where the UK is headed for sure until the last minute.

This all means that the MPC will need to be fleet footed. If it becomes apparent by the next MPC meeting on Thursday 17th December that there will be no deal, then the MPC may respond by loosening monetary policy next week. If that happens sooner or later than next Thursday, then the MPC could call an emergency meeting.

As for what it might do, the MPC would certainly try to quash any financial market dislocation triggered by accelerating its QE purchases. It’s a bit less clear what else it could do to support demand, but we suspect it would favour a package of targeted measures rather than the use of a single instrument. That would mimic the strategy used after the referendum and earlier this year. (See here.) All in all, we wouldn’t bank on next week’s meeting being the Committee’s last this year.

The week ahead

All eyes will now be on the Brexit talks concluding on Sunday. Otherwise, we expect the data to show that things will get worse before they get better.


Data Previews

Labour Market (Oct./Nov.) Tue. 15th Dec.

Forecasts

Time (GMT)

Previous

Consensus

CE

LFS Employment (3m/3m, Oct.)

07.00

-164,000

-252,000

-230,000

ILO Unemployment Rate (Oct.)

07.00

4.8%

5.1%

4.9%

Claimant Count (m/m, 000s, Nov.)

07.00

-29,800

0

Av. Earnings (inc. bonuses, mm 3m/yy, Oct.)

07.00

+0.2%(+1.3%)

+0.3%(+2.3%)

+1.0%(+2.4%)

Previous unwinding of furlough scheme takes its toll

The winding back of the furlough scheme may have led to 90,000 job losses in October and a rise in the unemployment rate from 4.8% to 4.9%. But with the rollout of vaccines set to boost demand in 2021, we now think that the jobless rate will peak at 7% rather than 9% and be back at 4% by 2023. (See Chart 1.)

Since firms were required to shoulder a greater burden of the cost of their employees’ salaries in October, they probably cut staffing levels at a quicker pace. We have pencilled in a fall in employment of 90,000 m/m in October. Because the published headline figure compares the average level of employment in the three months to October to the average level in the three months to July, this is likely to show up as a larger drop of 230,000. That would push the three-month unemployment rate up from 4.8% to 4.9%. But it may not be all bad news. The claimant count was probably stable in November due to the extension of the furlough scheme. And we have pencilled in a 1.0% m/m rise in earnings in October, as those who came off furlough and kept their jobs went from receiving 80% of their salary to 100%.

Chart 1: ILO Unemployment Rate (%)

Sources: Refinitiv, Capital Economics

Consumer Prices (Nov.) Wed. 16th Dec.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Consumer Prices m/m(y/y)

07.00

0.0%(+0.7%)

+0.1%(+0.7%)

+0.1%(+0.6%)

Core Consumer Prices m/m(y/y)

07.00

+0.2%(+1.4%)

+0.1%(+1.4%)

+0.1%(+1.3%)

Pockets of inflation, but outlook subdued

November’s lockdown and the continuation of COVID-19 restrictions for some time after will probably keep inflation below 1.0% over the coming months. And while inflation will rise in 2021, we doubt it will spend much time above the 2.0% target, unless a no deal Brexit pushes it up to a peak of 3.0-4.0%.

The bulk of the increase in CPI inflation from 0.5% in September to 0.7% in October was due to rises in clothing inflation, from -1.5% to 0.0% and food inflation, from -0.3% to +0.5%. Food inflation may have risen a little further to +0.6% in November as the lockdown boosted demand at the supermarkets once again. But it is hard to see how clothing inflation rose further in such conditions. We suspect it fell back from 0.0% to -0.2%. (See Chart 2.) Some pandemic-induced bursts of inflation, such as IT equipment inflation also probably continued to ease, perhaps from 6.4% to 4.5%. The net result may be that CPI inflation fell from 0.7% in October to 0.6% and core inflation slipped from 1.4% to 1.3%.

Chart 2: CPI Inflation for Clothing & Food (%)

Sources: Refinitiv, Capital Economics

IHS Markit/CIPS Flash PMIs (Dec.) Wed. 16th Dec.

Forecasts

Time (GMT)

Previous (Final)

Consensus

Capital Economics

Flash Composite PMI

09.30

49.0

51.3

50.0

Flash Manufacturing PMI

09.30

55.6

54.8

56.0

Flash Services PMI

09.30

47.6

50.4

50.0

Smaller fall means smaller bounce

The upward revisions to November’s final PMIs from the flash estimates suggest that activity started to recover even before the COVID-19 lockdown ended on 4th December. As such, we suspect the PMIs rebounded further in December, albeit to a level consistent with only modest GDP growth.

The 3-point fall in the composite PMI in November was tiny compared to the 39-point plunge during the first lockdown, which confirmed that the economy hasn’t been hit as hard by the second lockdown. (See Chart 3.) That was mainly as the services PMI didn’t fall as far, but was also due to stockbuilding ahead of Brexit aiding a rise in the manufacturing PMI.

As such, there is less scope for big rebounds in the PMIs now parts of the economy have reopened. We suspect that stockbuilding helped the manufacturing PMI to rise further in December, from 55.6 to 56.0. And we’ve pencilled in a bounce in the services PMI from 47.6 to 50.0. That would be consistent with the composite PMI rising from 49.0 to 50.0, which points to stable GDP in December. However, that probably unplays reality as the PMI excludes retail activity, which probably leapt in December.

Chart 3: IHS/Markit Activity PMIs

Source: IHS Markit

Retail Sales (Nov.) Fri. 18th Dec.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Retail Sales Volumes (Including Petrol)

07.00

+1.2%(+5.8%)

-1.3%(+2.1%)

-6.0%(+0.1%)

Sales to fall, but by much less than the last lockdown

Retail sales almost certainly fell in November due to the lockdown, but the drop probably won’t be anywhere near as bad as in April.

Retail sales have been the standout performer this year, growing by 5.8% y/y in October. But the BRC survey suggests that the closure of all non-essential shops from 4th November wiped out those gains. (See Chart 4.) That said, there are three reasons why the drop won’t be as bad as April’s 18.1% m/m fall.

First, retailers have learnt from the first lockdown and increased their online presence. Second, consumers searching for a bit of extra cheer may have started Christmas shopping earlier than normal. Third, workplaces visits were down by 33% from their pre-crisis level in November compared to a 66% drop in April. As such, petrol sales should fall by much less than their 51.8% m/m fall in April. As a result, we suspect that retail sales will fall by 6.0% m/m in November, about a third of the 18.1% m/m decline they registered during the last lockdown.

Chart 4: BRC Implied Real Sales

Sources: Refinitiv, BRC

Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Consensus*

CE Forecasts*

Data Response

Sun 13th

UK

“Deadline” for a decision on Brexit talks

Mon 14th

No Significant Data Released

Tue 15th

UK

Change in Employment (Oct)

(07.00)

-164,000

-252,000

-230,000

DR

UK

ILO Unemployment Rate (Oct)

(07.00)

4.8%

5.1%

4.9%

DR

UK

Average Earnings Inc. Bonus (Oct)

(07.00)

+0.2%(+1.3%)

+0.3%(+2.3%)

+1.0%(+2.4%)

DR

UK

Average Earnings Ex. Bonus (Oct)

(07.00)

+1.0%(+1.9%)

-0.1%(+2.6%)

+0.5%(+3.3%)

DR

UK

Claimant Count (Nov)

(07.00)

-29,800

0

DR

UK

Claimant Count Unemployment Rate (Nov)

(07.00)

7.3%

7.3%

DR

Wed 16th

UK

CPI (Nov)

(07.00)

0.0%(+0.7%)

+0.1%(+0.7%)

+0.1%(+0.6%)

DR

UK

Core CPI (Nov)

(07.00)

+0.2%(+1.4%)

+0.2%(+1.4%)

+0.1%(+1.3%)

DR

UK

CPIH (Nov)

(07.00)

0.0%(+0.9%)

+0.3%(+0.9%)

+0.1%(+0.8%)

DR

UK

RPI (Nov)

(07.00)

0.0%(+1.3%)

+0.1%(+1.2%)

+0.3%(+1.4%)

DR

UK

PPI Input (Nov, nsa)

(07.00)

+0.2%(-1.3%)

+0.4%(-0.5%)

+0.4%(-0.5%)

DR

UK

PPI Output (Nov, nsa)

(07.00)

0.0%(-1.3%)

+0.2%(-0.5%)

+0.2%(-0.5%)

DR

UK

IHS Markit/CIPS Composite PMI (Dec, Flash)

(09.30)

49.0

51.3

50.0

DR

UK

IHS Markit/CIPS Manufacturing PMI (Dec, Flash)

(09.30)

55.6

54.8

56.0

DR

UK

IHS Markit/CIPS Services PMI (Dec, Flash)

(09.30)

47.6

50.4

50.0

DR

Thu 17th

UK

BoE Monetary Policy Decision (Dec)

(12.00)

0.10%

0.10%

0.10%

DR

UK

BoE QE Announcement (Dec)

(12.00)

+£895bn

+£895bn

+£895bn

DR

UK

BoE Rate Votes (Nov, hike-unchanged-cut)

(12.00)

(0-9-0)

(0-9-0)

DR

UK

BoE QE Votes (Nov, reduce-unchanged-increase)

(12.00)

(0-9-0)

(0-9-0)

DR

Fri 18th

UK

GfK Consumer Confidence (Dec)

(00.01)

-33

-31

-30

UK

Retail Sales Inc. Fuel (Nov)

(07.00)

+1.2%(+5.8%)

-1.3%(+2.1%)

-6.0%(+0.1%)

DR

UK

CBI Industrial Trends Survey (Dec)

(11.00)

-40.0

Selected future data releases and events

Tue 22nd

UK

Public Finances (Nov)

(07.00)

DR

UK

GDP (Q3, Final)

(09.30)

+15.5%(-9.6%)p

DR

*m/m(y/y) unless otherwise stated

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

+15.5(-9.6) (Q3)

-2.5(-2.1)

-19.8(-21.5)

+15.5(-9.6)

-3.5(-12.9)

(+1.3)

(-11.5)

(+7.5)

(+7.5)

CPI inflation

(+0.7) (Oct)

(+1.7)

(+0.6)

(+0.6)

(+0.7)

(+1.8)

(+0.9)

(+1.6)

(+1.7)

ILO unemployment rate (%)

4.8 (Sep)

4.0

4.1

4.8

5.2

3.8

4.5

6.3

4.8

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 (%)

0.18

0.39

0.18

0.25

0.50

0.83

0.50

0.50

0.50

$/£, end period

1.32

1.24

1.25

1.29

1.35

1.33

1.35

1.40

1.45

Euro/£, end period

1.09

1.14

1.14

1.14

1.13

1.18

1.13

1.12

1.12

Sources: Capital Economics, Refinitiv

* Assumes that severe COVID-19 restrictions are in place during November, December and January and that lighter, diminishing, restrictions are in place in February, March and April and vaccines are widely available from Q2/Q3. (See here.) Assumes the UK and EU agree a slim trade in goods deal by the end of the year. (See here.)


Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, ruth.gregory@capitaleconomics.com