Ongoing lack of Brexit clarity will only further depress UK economy

Ongoing lack of Brexit clarity will only further depress UK economy

Last Friday’s UK GDP data for the second quarter of the year provided further evidence that Brexit-related uncertainty is acting as a headwind to the British economy.

The first estimate of UK GDP for the three-month period of April to June showed that the UK economy contracted by 0.2% compared to the first three months of the year.

This represented the UK economy’s first contraction since the last quarter of 2012. On a year-on-year basis, growth slowed to 1.2% in quarter two.

Looking at the breakdown of the data, it appears that the economy in the second quarter was impacted by activity being brought forward into the first quarter ahead of the original Brexit deadline of March 29.

This was evident in a reversal in stock-building and weakness in net exports.

The outlook for the UK economy remains highly uncertain. Ultimately, its performance is contingent on the final form that Brexit takes.

Until a clearer picture emerges, uncertainty is likely to continue to depress activity.

In its recent World Economic Outlook publication, the IMF was pencilling in growth of 1.3 this year and 1.4% for 2020 for the UK economy.

These forecasts assume an orderly Brexit, including the implementation of a transition phase.

However, the risks of a no-deal disorderly Brexit appear to have increased in recent weeks.

The mounting concerns over this scenario has been reflected in the performance of sterling, which has come under sustained downward pressure.

In level terms, this weakness in the pound has seen the EUR/GBP pair move up to the 93p mark, for the first time in over two years.

The uncertainty surrounding Brexit is not just causing issues for UK businesses and consumers, it is also creating difficulty for the Bank of England in assessing the economic outlook and what the appropriate stance of monetary policy should be.

Indeed, in its policy-setting meeting back at the start of this month it made numerous references to the complications that Brexit was causing for its policy deliberations.

In the post-meeting press conference, governor Mark Carney commented that UK macro data had become more volatile than usual due to the UK’s pending exit from the EU.

He also said that, looking through these distortions, it was clear that the underlying pace of growth in the UK economy had slowed to "below-potential rates".

Overall, the Bank of England is very much in wait-and-see mode.

It is awaiting clarity on how Brexit will evolve and the consequences this will have for its monetary policy outlook.

If a no-deal Brexit develops it is likely the Bank of England will act by cutting interest rates.

Meanwhile, if its assumption of a smooth Brexit materialises, combined with "some recovery in global growth" then this could bring rate hikes back on the policy agenda for the Bank of England next year.

In this regard, Britain's central bank continues to be of the view that increases in interest rates, albeit at a gradual pace and to a limited extent, are required in order for it to achieve its inflation objective of 2%.

In terms of market expectations, futures contracts indicate that the market is expecting the next move from the Bank to be a rate cut.

A 25 basis points reduction in the bank rate is envisaged by the first quarter of 2020.

This expectation is against the backdrop of increased concerns over the risks of a no-deal hard Brexit and the weaker global macro environment.

John Fahey is senior economist at AIB

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