UK—COVID-19 resurgence and no-deal Brexit risk to weaken potential growth

Even before COVID-19, the UK’s growth performance lagged many advanced economies amid persistently low productivity growth, tepid business investment, and Brexit-related uncertainty. But the pandemic has hit the UK economy particularly hard given the relative severity of the outbreak to date and the economy’s reliance on tactile services. Indeed, the UK suffered the sharpest economic contraction of any G7 country in the second quarter. While GDP in August was 22% higher than its lowest ebb during lockdown in April, it remained 9% below pre-pandemic levels. Economic recovery will face challenges from tightening mobility restrictions in response to resurgent COVID-19 infections (Chart) and the increasing likelihood of failed EU trade negotiations.

If a UK-EU trade agreement isn’t signed by early-November, allowing time for ratification before the expiry of the transitional arrangement on December 31, trade barriers and business costs will rise significantly. While financial markets seemingly believe a deal will be finalised, Downing Street has warned traders to get prepared for a no-deal outcome. Disagreement remains on state-subsidy rules, dispute settlement and fisheries. However, 45% of polled companies reported not being prepared for the end of the transition period, with 75 days to go. Even if a trade deal is agreed, it will likely be narrow in scope and therefore ill placed to arrest downward pressure on private investment. Indeed, Moody’s downgraded the UK sovereign rating this month highlighting the ‘self-reinforcing combination of low potential growth and high debt in a fractious policy environment’.

Australia’s exports to the UK doubled to a record $21 billion in 2019, including due to increased exports of gold, advanced manufacturing products and clothing accessories. However, the UK’s low growth potential—arising from short term challenges and structural deficiencies—weighs on the outlook.