Bank of England warns no-deal Brexit will crush the UK economy

Leaving the EU without a deal could spell major disruption for the UK economy. Markets, however, may have already priced that in. 

Economy and Policy November 29, 2018 by Tom Bailey

Leaving the European Union without a deal could cause the largest contraction since the Second World War for the UK’s economy, according to the latest warnings from the Bank of England.

In analysis produced for to the House of Commons Treasury Committee, the Bank outlined the potential economic impact of various ways the UK might leave the UK.

In the worst case scenario, whereby the UK leaves with no formal arrangement or agreements replacing those ended by the UK’s exit from the union, the Bank warns of major economic disruption.

As the chart below shows, the Bank believes the UK could see its GDP drop somewhere between roughly 7% and 10%. In this scenario, economic growth could be expected to return by 2023.

At the same time, the Bank of England also anticipates scenario where sterling falls by up to 25%. This would result in further import inflation, with the Bank anticipating inflation reaching levels above 6%.

The Bank’s governor, Mark Carney, noted that there is little monetary easing could do to offset the results of a no-deal Brexit.

The governor has noted: “There is little monetary policy can do to offset the potentially significant hits to productivity and supply that Brexit could entail... the future potential of this economy and its implications of jobs, real wages and wealth are not in the gift of central bankers.”

At the same time the Bank would be constricted by its need to temper rising inflation.

What does it mean for investors?

Many UK investors appear fairly sanguine about the impact of a no-deal Brexit on markets. Many commentators have been pushing the idea that a no-deal Brexit is already baked into equity prices, meaning that a no-deal might only see a muted response from markets.

James Bateman, chief investment officer for multi asset at Fidelity International notes that when it comes to Brexit, markets have already considered the various outcomes of the UK attempting to leave the EU. He adds: “Markets have already envisioned the various ways it will go. There is a fixation on Brexit. But if everyone is fixated on Brexit, it is not the risk to worry about.”

Indeed, many international investors have already fled the UK. Since the announcement of the referendum, international investors have largely rotated out of UK equities. As Alastair Mundy, manager of Temple Bar, points out: “International investors seem to have decided that Brexit is too hard. They don’t know the outcome and so have given up on the UK.

However, while markets may have priced in a no-deal Brexit, there are potential other outcomes which could trigger fruther selling of UK assets.

According to Rupert Thompson, head of research at KW Wealth, there is the risk that a no-deal would trigger a general election, possibly resulting in a Corbyn-led Labour government. A Labour government under Corbyn, he warns, would "very likely lead to a further significant sell off in UK markets even though the pound and UK equities are already trading at cheap levels."

Most hit, Thompson notes, would be domestic-focused and mid/small cap UK stocks, with their earnings would be more exposed to the domestic economic disruption. In contrast, the FTSE 100 would be somewhat shielded, with most companies on the index seeing their earnings coming from abroad and therefore being bolstered by a weak pound.

On the other hand, says Thompson: "Domestic focused companies would however have the advantage that the primary source of disruption would be to trade flows and they will be less exposed to such disruption than companies more dependent on imports and exports."

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