A winter wave of Covid-19 infections coupled with a no-deal Brexit outcome would derail the UK’s economic recovery from the pandemic despite promising initial projections of a record bounce back in GDP later this year.
The economic fallout from the coronavirus crisis has overshadowed the UK’s divorce from the European Union for the better part of 2020. But as trade talks between the EU and UK continue to stall, this time over the passageway for British truckers in the EU, the threat of a no-deal Brexit has once again reared its ugly head.
Leaked documents detailing the government’s worst-case scenario of a hard Brexit and second wave of coronavirus paint a grim picture of bankrupt councils, public disorder, food shortages and hospitals overrun by Covid-19 and seasonal flu patients, and have only added to the sense of dread.
UK economy could see ‘double-dip recession’ amid second wave
JP Morgan Asset Management global market strategist Mike Bell (pictured) says a no-deal Brexit coupled with a winter wave of infections and rising unemployment would create a perfect storm for the UK economy.
Bell says the UK risks suffering a “second shock” if the 13% of workers furloughed suddenly find themselves unemployed when the government turns off its fiscal support at the end of October.
A winter wave of infections would hinder Britain’s economic recovery, he says, and could lead to further restrictions on activity, resulting in a “double-dip” recession as additional jobs are lost beyond those currently on furlough.
“A no-deal Brexit would only serve to exacerbate the hit to the economy and employment,” Bell says.
UK GDP plunged by 20.4% in Q2, worse than the US, eurozone and all other G7 nations, pushing the economy into its deepest recession on record after the 2.1% contraction in Q1.
But City analysts are projecting the UK is set to enjoy a record-breaking bounce back in Q3 with GDP rising 14.3% in the three months to 30 September driven by consumers splashing cash again after the lockdown period.
Brexit deal will be ‘bare bones’ at best
Most of the industry professionals Portfolio Adviser spoke to believe the UK and EU will be able to strike some kind of a deal by the end of the year albeit a skeletal one at best.
“The rhetoric around the Brexit deal changes if not day by day then certainly week to week,” says BMO Gam multi-manager Scott Spencer, who adds that given the UK’s “emotive” sticking points of fishing waters and state aid for industries, there is a “slim but real possibility of a no-deal”.
Despite the protocol over Northern Ireland and the EU’s demand for “a level playing field” being agreed in the withdrawal agreement, Hetal Mehta, senior European economist at LGIM, reckons negotiators remain divided over these issues, along with the most recent squabble over access for British truckers.
“Our current expectation is that even if a deal is reached, it will be a ‘bare bones’ one, largely avoiding tariffs,” she says. “That still constitutes quite a hard Brexit and leaves the services sector without a deal in place and subject to significant non-tariff barriers like regulations.”
Tilney multi-asset head Ben Seager-Scott says the economic fallout from the coronavirus has shifted the dynamics for both sides and created stronger incentives to have some kind of deal.
“We have seen before that he EU are masters of kicking the can down the road, so on balance I would expect there to be some sort of ‘muddle-through’ deal that won’t make everyone happy but probably makes all sides only marginally unhappy.”
‘A second wave would change the outlook completely’
BNY Mellon Investment Management’s chief economist Shamik Dhar thinks the odds of the UK leaving without a deal are currently around 50/50. But he believes the UK and EU will probably scrape together a deal last minute toward the end of October.
Dhar, who advised on the initial Brexit talks as chief economist at the Foreign Office, says he is more optimistic than most that neither a hard Brexit outcome or Covid will result in long-lasting scars for the UK economy.
“The calculations I was making when I was at the Foreign Office and here at BNY Mellon were that worst case, a no-deal Brexit could cost the UK economy between 1-2% of GDP, which is significant and something you definitely want to avoid but it’s not the seven, eight, 9% percent of GDP that some people were talking about,” he says. “And it certainly pales by comparison with the economic impact that Covid has had in the first half of this year.”
Dhar estimates the UK will open a quarter of the economy that was shut down per quarter over the next four quarters, bringing Britain back to pre-crisis levels by the middle of 2021, much sooner than other projections which put the economy back on its feet by late 2021 or early 2022. By that point he expects the employment rate to also have recovered.
“If I’m right, that aggregate spending gets back to pre-crisis levels by the middle of 2021, then there’s no reason why aggregate employment shouldn’t be at similar levels as well because if we’re spending as much there’s no reason why we shouldn’t be shouldn’t be creating as many jobs”
A second wave could “absolutely change the outlook completely,” Dhar admits, though he thinks this is something the UK will be able to avoid.
UK slump is ‘a trend that’s been going on for years’
Spencer thinks a second wave, if the UK gets one, presents less of a risk to the UK’s economic recovery.
“It is our view that governments around the world, and not just in the UK, will now pursue localised and temporary measures to deal with outbreaks,” he says.
“At the same time, death rates are falling, and treatments are getting better and there is likely to be less risk of a health system collapse.”
BMO Gam’s multi-manager portfolios are currently overweight UK equities due to valuations being dirt cheap. While Spencer says it is possible markets could take a turn for the worse in the event of a hard exit, he thinks UK stocks could also rally at the end of the year with any uncertainty being removed.
LGIM’s base case is that the UK economy will still be below pre-virus levels by the end of 2021.
Mehta says the severity of the UK’s performance slump is not simply due to the “unusual circumstances of a single quarter” but is the result of “a trend that’s been going on for years”.
Though other political risks which made the UK un-investable have dissipated, such as a possible Jeremy Corbyn-led government, the Brexit risks “remain significant”.
“Brexit-related news flow has arguably been notably worse than many would have expected after the 2019 election.
“Consequently, slower investment and higher trade frictions and uncertainty make us cautious about the UK’s growth prospects beyond the immediate virus-related bounce.”
By Kristen McGachey, 2 Sep 20