UK Macro: Bare bones trade deal the most likely outcome – The deadline for an extension to the 31 December end to the Brexit transition period passed 1 July with little fanfare. The UK government had been signalling for some time that it had no appetite to extend the deadline, despite the economic crisis resulting from the pandemic. What does this mean for the negotiations, and the outlook? With our most recent downgrade to the growth forecast, we had already assumed as a base case that there would be no extension to the transition period, and that the UK would leave the single market at the end of 2020 with a ‘zero tariffs, zero quotas’ trade deal covering goods trade, but with little meaningful likely to be agreed on services. With such a deal in place, the most potentially disruptive aspects of Brexit – prohibitive tariffs on goods, strict border checks causing long queues, and even planes not being able to fly – would be avoided. However, the significant extra administrative burden of customs declarations and even lighter touch border checks, plus the uncertainty over the stability of the agreement, will create extra friction in goods trade – potentially reducing trade by 40% over 10 years compared with an EU membership counterfactual (as per estimates by the NIESR). More importantly, the lack of a comprehensive agreement on services will hobble the UK’s most successful export, particularly over the medium-long run.
Regardless of the Brexit outcome, the near-term impact will be dwarfed by the pandemic – There is still a significant risk that a deal will not be reached in good time to be implemented by 1 January, particularly given that any deal must be ratified by national and regional parliaments across the EU27. However, with the ambition level for a deal much lower – far less comprehensive than the ‘deep and special partnership’ proposed by the previous May administration – the bar for reaching agreement is also notably lower. The difference between a trade deal in goods and no trade deal at all is also correspondingly smaller. The most significant near-term effect of no-deal would be the disruption caused by border delays and the possible second-round effects from making certain exports unviable (and therefore leading to factory closures and layoffs), which could take 1-2pp off 2021 growth. In normal times this would be a significant hit to the economy, however in the context of the pandemic it is a relatively small hit. We expect the UK to be one of the worst hit of the advanced economies given the very severe outbreak there and the lengthy, strict lockdown. This will see GDP falling by 8.5% in 2020, only partially recovering that lost ground in 2021, when we expect growth of 5.2%. A poor Brexit outcome could further dent that recovery, but the outlook in any case is a very weak one.