OECD warns against hard Brexit

FILE PHOTO: An EU flag flutters outside the Houses of Parliament, as uncertainty over Brexit continues, in London, Britain May 15, 2019. REUTERS/Hannah Mckay

In an already unfriendly economic climate, the Organisation for Economic Co-operation and Development (OECD) has warned that a no-deal Brexit would mean recession for the UK and would also drag the rest of the EU down with it. The OECD warnings come hot on the heels of other dire warnings, namely a bleak set of forecasts for the global economy. It downgraded world growth from 3.2 per cent to 2.9 per cent for this year and from 3.4 per cent to 3 per cent for 2020, which it said were “the weakest annual growth rates since the financial crisis”.

No-deal Brexit risks were set against the backdrop of an “increasingly fragile and uncertain” global economy. Global trade volumes are declining for the first time since 2016, and “new export orders are contracting in around two-thirds of the economies with available survey data”.

Hard Brexit = Hard Times

Economic observers noted that even if the UK puts in place interest rate cuts and fiscal stimuli, the UK economy would shrink in 2020 by about 1 per cent in the event of a hard Brexit on October 31. OECD data said that growth might return in 2021 and 2022 but the economy would be weaker in both years than with a deal. In the UK the OECD expects the economy to expand only 1 per cent this year, down from its forecast 1.2 per cent in May, and by 0.9 per cent in 2020, a downgrade of 0.1 percentage points. The assumption that the UK will grow, even if weakly, is based on a smooth transition to a Brexit deal. “A no-deal exit would be costly in the near term, potentially pushing the UK into recession in 2020 and reducing growth in Europe considerably,” the OECD said.

“Even a relatively smooth no-deal exit, with fully operational border infrastructure, would have large costs. GDP declines by close to 2 per cent in 2020, pushing the economy into recession given the baseline projection, with the near-term costs continuing to rise in 2021-22” said the OECD. Its formal projections showed that the economy would shrink by about 0.7 per cent next year.

In the euro area and the EU27 as a whole GDP would be about 0.5 percentage points lower than otherwise in 2020 after a no-deal Brexit. Within the EU, Ireland would be hit hardest, “where GDP drops by around 1.5 per cent in the near term” against baseline forecasts.

 OECD’s no-deal projections are more realistic than other forecasters’ worst cases because they assume “fully operational border infrastructure”, as both the EU and UK intend; a rate cut from 0.75 per cent to 0.25 per cent by the Bank; and stimulus from the government. The budget deficit is assumed to rise by £15 billion in 2020.

OECD data indicates that a hard Brexit would mean that the Sterling would fall another 5%, to about $1.18, against present levels, and inflation would rise by 0.75 percentage points to close to 3%, squeezing household incomes. The projections show that business investment would decline 9 % and borrowing costs rise as the risk premium on UK assets increases by a whole percentage point, more than undoing the rate cut.

“If preparations to border infrastructure fail to prevent significant delays, or if financial market conditions were to deteriorate considerably, or if consumer confidence were to decline sharply, the near-term impact of a no-deal Brexit could be much more costly,” the OECD said.