Brexit update: Economic and political implications

The UK parliament yesterday (15 January) rejected decisively by 432 votes to 202 the government's recently concluded deal with the European Union, which was designed to allow for an orderly UK exit from the EU on 29 March. The likelihood of the current arrangement being implemented on time, or indeed altogether, has now been greatly reduced. In terms of our UK growth projections, the impact of yesterday's vote is likely to be limited because of conflicting pulls, but it does provide support to our cautious assessment when compared with the consensus.

Key points

• As expected, the lack of political consensus on what Brexit means for the UK led to the country's parliament rejecting the draft Withdrawal Agreement and Political Declaration, implying that continued uncertainty is likely to weigh down on economic sentiment and activity.
• Given UK parliament's rejection of the deal, the probability of the current arrangement being implemented on time, or indeed altogether, is reduced.
• The UK corporate sector had broadly backed the Withdrawal Agreement as the first step towards a more business-friendly settlement but feared that political divisions around the exit agreement threatened to scupper the plan. After yesterday events, firms remain highly uncertain about the Brexit political process, and are increasingly frustrated that a "no deal" scenario remains an option, implying continued contingency planning.
• With regards to our near-term growth projections, the impact of yesterday's lost vote is likely to be limited because of conflicting pulls, but it does provide support to our more cautious assessment when compared with the consensus.
• Our scenario continues to predict that the economic consequences of a no-deal Brexit would be significant. The UK economy lacks sufficient strength to absorb the full impact of a chaotic Brexit.
• The no-deal scenario assumes that the UK would be in recession from mid-2019 to early 2021, and that its economy would contract by 0.9% in 2019, 2.4% in 2020, and 0.5% in 2021. By 2026, real GDP would be 9% lower in the no-deal scenario when compared with the September 2018 baseline, which assumes an orderly exit and transition period for the UK.

Outlook

The government's defeat implies a broad array of possible pathways on future Brexit proceedings. Most MPs are strongly opposed to a "no deal" Brexit in which the UK would leave the EU without any formal arrangements in place.

In the absence of an exit deal, all alternative next steps - excluding a "no deal" Brexit or revoking Article 50 procedures and hence stopping Brexit - would most likely require a delay to Brexit. In accordance with the EU's Lisbon Treaty, such a delay would have to be unanimously supported by all remaining 27 EU member states. Although there is a degree of preparedness to continue accommodating the UK's domestic political turmoil, the EU is unlikely to agree to any extension of the Brexit deadline beyond 2 July 2019, at which point the EU enters a new term.

With regards to economic signposts, we acknowledge the uncertainty enveloping economic activity witnessed in late 2018 is likely to spill into 2019. The lingering risk of a "no-deal" Brexit could encourage consumers and firms to bring forward purchases to protect themselves from the possibility of a <span/>no-deal exit on 29 March 2019. Firms are elevating their stock levels in anticipation of acute shortages should the UK depart the EU with no deal. UK firms remain nervous about the Brexit end-game, highlighted by poor business sentiment. This is an acute downside risk to future investment and employment intentions, which underpins our cautious short-term growth assessment.

An array of complex challenges, such as border management and trade relations, remain. Fundamental questions about the nature of the future UK-EU relationship remain unanswered. Therefore, we anticipate a challenging UK growth landscape in 2019-20, with the balance of risks tilting to the downside. Clearly, the lack of clarity about how the Brexit political process will evolve suggests further downward pressure on our near-term growth projections.

Posted 16 January 2019 by Raj Badiani, Economics Director, Europe, S&P Global Market Intelligence