Can the UK economy rebound after Brexit?
The UK economy has been on the verge of recession recently. Whether it improves as Brexit uncertainty lifts largely depends on the UK government's approach to negotiations with the EU and the progress it makes. If it can avoid headlines about looming tariffs, then business confidence and investment can recover.
What risks remain?
During the current transition period, the economic relationship between the EU and UK is largely the same as before but the UK will no longer take part in the political processes of the EU. Both sides will negotiate the rules and parameters of the future relationship. With best efforts being made to prepare for the worst possible outcome, the risk of a sudden stop to trade and possible shortages of goods is still a real danger. In the absence of a trade agreement or an extension to the transition deal, the UK could be facing the same no-deal or cliff-edge Brexit at the start of 2021.
How might the UK approach negotiations?
Talks on the future relationship will begin in spring. They will start by considering issues such as:
- What should happen if the UK decided to diverge from the EU's common standards?
- What happens should the EU choose to change those standards?
- Will the UK be consulted beforehand?
- Who decides whether either side has broken the agreement?
- What will be the consequences of breaking the agreement?
Once these issues have been resolved, talks can become more granular.
At this stage, we expect the UK government to pursue a sector-by-sector approach to negotiations, rather than an all-encompassing deal. This is because the EU will not want the final outcome to resemble full single market access if the UK is not willing to agree to the free movement of people. Moreover, full membership of the customs union is impossible if the UK wants to pursue independent trade deals.
Which sectors are the UK’s priorities?
The UK is likely to prioritise manufacturing sectors, in particular, the auto industry, chemicals and machinery. A sectoral approach, rather than “all-or-nothing”, may reduce the risk of a no-deal outcome at the end of the transition period.
Sectors that are excluded are likely to face tariffs, but they may be compensated by the government. The UK might push for a new transition agreement for these sectors to limit the impact on businesses, with a view of agreeing a "phase-two" deal to cover them.
Meanwhile, the UK government is already working on replacing many of the existing EU trade deals with third parties that will soon lapse.
Will economic activity rebound?
With Brexit now certain and a trade negotiation underway shortly, the flash Markit purchasing managers' indices (PMIs) for January has shown a notable jump - positive signs for a rebound in activity. However, it will take some time for the official data to catch up.
A significant handicap in the short-term is the build-up of inventories (or stockpiles) which took place last year to protect against a no-deal Brexit outcome. Inventory levels are now being reduced but they still remain high. This means the recovery in production and output could be delayed while inventories are run down, which suggests that GDP may not rebound much before the second half of the year. However, once it does, the UK should enjoy above average growth through at least 2021.
Yet, the recovery will depend on the UK government's ability to make progress in trade negotiations, and equally as important, avoid brinkmanship in negotiations. If businesses see headlines about World Trade Organisation (WTO) tariffs looming, then currency volatility will return, and businesses will retrench.
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