Monday, September 09, 2019
/04:20PM / By Fitch Ratings / Header Image Credit: China Briefing
A 'no-deal' Brexit remains a significant risk due to UK political volatility, despite manoeuvres in parliament to try to prevent it, Fitch Ratings says. The nature and timing of the UK's exit from the European Union remain uncertain, and the risk that a no-deal departure causes substantial disruption to UK economic prospects is reflected in the Rating Watch Negative (RWN) on the UK's 'AA' sovereign rating. The economic impact of persistent Brexit uncertainty is already clear.
MPs on Tuesday passed a bill that would require Prime Minister Boris Johnson to ask for a three-month extension to the Article 50 process if a withdrawal deal with the EU has not been secured by 19 October, unless parliament votes for a no-deal exit. Johnson now leads a minority government (21 MPs from his governing Conservative party were expelled for supporting efforts to prevent a no-deal exit). The government subsequently lost a parliamentary vote that would have triggered a general election. It plans to call another vote early next week, but opposition parties have said they will oppose this.
Developments are consistent with our view that UK political volatility would intensify in the run-up to the 31 October Brexit deadline. An early election is now the most likely outcome but its timing is unclear. The government, which has pledged not to request another extension, has said it wants to hold a snap election ahead of the EU Council meeting on 17-18 October with a view to potentially securing a new withdrawal deal. The opposition Labour party appears likely to seek to delay an election beyond 31 October.
A UK election campaign will be fought on Brexit and is likely to further polarise the country. It is possible that a snap election could return a majority government determined to take the UK out of the EU at the end of October or the earliest opportunity thereafter. Conversely, it could produce another hung parliament or a government (possibly via a coalition agreement) that would hold a second referendum, or seek a longer Article 50 extension to try to renegotiate the existing withdrawal agreement. Another extension would require unanimous agreement from the EU27 and renegotiation would continue to present challenges, in particular in relation to the Irish backstop.
In Fitch's view, a no-deal Brexit would lead to substantial disruption to UK economic and trade prospects, at least in the short term. This was reflected in our decision to maintain the RWN on the UK's rating at our most recent review on 26 April. Brexit-related uncertainty is already weighing on the UK economy. Business investment has been persistently weak over the past year. Real GDP contracted in 2Q19 and although this was mainly due to the inventory cycle driven by the previous Brexit deadline in April, it points to weaker annual growth than we forecast in our June Global Economic Outlook. We have therefore reduced our UK growth forecast for 2019 to 1.1% from 1.4%.
These baseline forecasts are based on a working assumption that a no-deal Brexit is avoided. Given the lack of clarity around political outcomes, we have also updated our no-deal scenario. The impact on growth would be highly uncertain, but a recession on the scale of the early 1990s would be a reasonable comparison for gauging the potential macroeconomic stress.
We think a no-deal departure could result in GDP falling by more than 3% over two years relative to our baseline (or more if 'bare-bones' UK-EU trade arrangements are not secured) and would be likely to prompt renewed monetary and fiscal easing. A no-deal exit on 31 October would see a sharp quarterly real GDP contraction in 4Q19, reducing real GDP growth to 0.8% for the whole of 2019. Real GDP would then contract by 1.4% in 2020, compared with our June 2019 GEO forecast of 1.5% growth. Unemployment would rise to 5.5% in 2020, compared with our baseline of 4.2%.
Policy assumptions include the Bank of England cutting rates in two steps to 0.25% by January 2020 and renewed quantitative easing including via the Term Funding Scheme. We also assume some discretionary fiscal easing. Policy easing, import substitution and some unwinding of the near-term trade disruptions would be likely to help growth recover in 2021.
Weaker growth prospects would carry through to the public finances, either through the impact of automatic stabilisers or due to looser fiscal policy to address the shock to the economy of a no-deal scenario. Meanwhile, the UK Spending Review announced on 4 September, which envisages spending on public services rising 4.1% in real terms between 2019-2020 and 2020-2021, underscores our view that austerity fatigue and Brexit have increased uncertainty about the outlook for public finances, contributing to the risk reflected in the RWN. We will factor the spending plans into our fiscal projections before our next scheduled UK sovereign rating review, due on 18 October.