What are the Implications of a “Hard Brexit” to the UK Economy?
Almost four months after the UK voted to exit the EU, the fog is slowly lifting. It is becoming more and more evident that the British government under new Prime Minister Theresa May is heading for what the media are calling a “hard Brexit.”
In a hard Brexit — which is currently the most realistic scenario forecast by Dun & Bradstreet — the UK would give up access to the EU’s common market in exchange for regaining control over migration. A hard Brexit would have a significantly higher adverse business impact than a soft Brexit, given the strong trade and investment ties that have developed over the UK’s more-than-40-year-long EU membership.
Uncertainty, however, remains elevated as pressure on the government to hold a parliamentary vote on the issue is rising. Given that many backbenchers are unhappy about the government’s hard-Brexit stance, it is unclear if May would get parliament’s backing for a hard Brexit. (May currently has a wafer-thin parliamentary majority of 12 seats, a position that may not remain secure.)
Brexit Means Brexit
In the immediate months after May replaced David Cameron following his resignation, she was fairly tight-lipped about the UK’s Brexit policy goals. She repeatedly said, “Brexit means Brexit,” making it clear she would follow through with the referendum result despite having campaigned for the UK to remain in the EU. However, it remained unclear how post-Brexit UK-EU relations would look from the government’s point of view.
Then, during the Conservative Party convention in early October, May came forward and explained that Article 50 will be invoked in Q1 2017. She stated that the government will prioritize control over British borders, reinforcing the supremacy of UK law over EU law in the upcoming negotiation. As the EU is unwilling to grant the UK full market access without the freedom of movement, the UK is now heading for a hard Brexit.
Hard Brexit Timetable
Once Article 50 is invoked, divorce proceedings will have to be concluded 24 months later. Our current scenario has the British government invoking Article 50 in March 2017, leading to Britain’s EU membership expiring in March 2019.
However, two years will not be enough to complete the complex negotiations about the terms of the UK’s post-Brexit relationship with the EU. Therefore, Dun & Bradstreet forecasts a transitional agreement will go into effect in 2019.
Under a transitional arrangement, most, if not all, of the trade and investment regulations will remain unchanged compared to the pre-Brexit period, giving the UK enough time to complete the negotiations with the EU. Allotting this extra time, however, may come at the expense of the UK making contributions to the EU’s budget and accepting the freedom of movement.
Complete negotiations are likely to conclude in the early or even mid-2020s. From then on, the UK would be able to revoke EU law and set its own regulations.
The Economic Impact
The prospect of a hard Brexit has already concerned markets. As a result, the British pound has depreciated further against the euro and the dollar.
According to Dun & Bradstreet’s baseline scenario, the weak pound will weigh on the inflation rate from early 2017 on, as importers of goods from the continent and overseas will try to pass price increases on to customers.
Against the backdrop of elevated levels of political uncertainty, the British economy is likely to enter much choppier waters in the next few months. This will lead to a deceleration of growth, and the pound will remain weak for the foreseeable future.
D&B previously lowered the UK’s risk rating by two notches from DB2a to DB2c immediately after the referendum. In light of more recent circumstances, there has been a further downgrade in UK’s risk rating to DB2d. This rating further maintains the country's deteriorating outlook, whilst also highlighting the risk of further downgrades in the months ahead.