UK Politics to Remain Volatile; No-Deal Risk Rises


Wednesday, July 24, 2019  / 11:25AM / By Fitch Ratings/ Header Image Credit: CNN International                          


The election of Boris Johnson as leader of the UK Conservative Party further increases the risk of a no-deal Brexit, but domestic political outcomes, and therefore the timing and nature of the UK's exit from the EU, are still highly uncertain, Fitch Ratings says. 

Johnson was confirmed as the new party leader on Tuesday following a ballot of party members, and will likely be asked to form a government on Wednesday. He was foreign minister in Theresa May's administration until he resigned last July in protest at plans for the UK's post-Brexit economic relationship with the EU. 

UK political volatility is set to intensify in the run-up to the extended 31 October Brexit deadline. The Conservatives have a small working majority in the House of Commons, and Johnson may struggle to restore the parliamentary party's cohesion (several ministers have refused to serve under him). 

The new Prime Minister inherits the same Brexit impasse as his predecessor. Johnson has expressed a willingness to leave with no deal and declared the existing Withdrawal Agreement 'dead'. But the EU has said the Withdrawal Agreement will not be renegotiated, and Parliament opposes no-deal (MPs last week voted by a majority of 41 for an amendment that would make it harder to suspend parliament in order to leave with no deal). 

Johnson has publicly committed to taking the UK out of the EU on 31 October. But efforts to break the parliamentary deadlock could lead to a range of outcomes, including a general election and/or a second referendum (which the opposition Labour party now supports in certain circumstances, although some Labour MPs are opposed). Meanwhile, it is unclear how individual EU27 member states would respond if the UK requested another extension (new European Commission President Ursula von der Leyen has said extension is possible with 'good reasons'). 

When we affirmed the UK's 'AA' sovereign rating on 26 April we said that domestic political volatility could lead to a no-deal Brexit which, in our view, would cause substantial disruption to UK economic and trade prospects, at least in the near term. This is one reason for the Rating Watch Negative (RWN) on the rating, which balances a high-income, diversified and advanced economy against comparatively high public sector indebtedness. 

Brexit-related uncertainty is weighing on UK growth, which had proved resilient following the 2016 EU referendum, although underperforming G7 peers. Underlying economic conditions appear fragile, with a relatively strong 1Q19 GDP outturn largely explained by stockpiling, and additional pressures from slowing world trade. Our GDP forecasts now assume below-trend growth in both 2019 and 2020 at around 1.4% (see Global Economic Outlook - June 2019). A no-deal Brexit could see GDP fall by 3pp relative to our baseline over two years (or more if the UK adopted a more confrontational approach that lessened the chances of a 'bare-bones' agreement) and would likely prompt renewed monetary and fiscal easing. 

Indeed, fiscal easing is highly probable regardless of the final Brexit outcome, as evidenced by significant tax and spending pledges made by Mr Johnson during the leadership campaign. Public finances have been resilient to weaker growth, and our projections in April pointed to the government debt to GDP ratio falling from 86.8% in 2018 to 84.6% in 2020. The UK's large fiscal adjustment has created some fiscal headroom. The Office for Budget Responsibility estimates that primary borrowing would have to increase by GBP21 billion-GBP25 billion for debt not to fall in any year between 2021-22 and 2023-24. However, in Fitch's view, austerity fatigue and Brexit have increased uncertainty about the outlook for public finances, contributing to the downside risk reflected in the RWN on the UK rating.

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