UK—Increased chance of no-deal Brexit

The intention of new Prime Minister, Boris Johnson, to deliver Brexit by 31 October with or without a new trading arrangement in place has increased the chance of a no-deal outcome.

The Bank of England has stated that without a deal, sterling would probably depreciate, inflation accelerate, and growth slow. But the severity and length of any slump is unclear, with some pundits tipping recession, while others see little impact, at least ‘once the smoke clears’.

Under any Brexit scenario, short term UK prospects will undoubtedly weaken, as the current frictionless border with the EU is replaced with some degree of hindrance. Without a deal, cross-border commerce will become particularly costly, slow and complex, as customs and compliance checks are instigated and tariffs imposed. Long delays are expected at border crossings, with factories reliant upon just-in-time delivery and dealers in perishable foodstuffs expected to suffer most.

What happens as the UK settles into a new long-run trading equilibrium is more debatable. Ideally, trade negotiations with other countries, notably the US, will open up new markets as access to the EU tightens, and trade merely reorients rather than shrinks. But in the worst case, this offset will be insufficient, causing trade to decline and the economy to become less open and dynamic.

The rising uncertainty caused the economy to contract in the June quarter (Chart). Many businesses are postponing investment until the outcome of negotiations becomes clear, and forward indicators such as the Manufacturing Purchasing Managers’ Index suggest momentum remains subdued heading into the second half of the year.

A prolonged drag on UK growth is a risk for Australian exporters, but there are also opportunities. The UK ranks as Australia’s seventh-largest bilateral trading partner. Scoping discussions for a future Australia-UK Free Trade Agreement have been underway since 2016, and the UK government has indicated it will give them a high priority after Brexit. This could provide opportunities for Australian businesses in the UK market.