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‘Hard Brexit’ is the worst-case economic scenario for UK

‘Hard Brexit’ is the worst-case economic scenario for UK

05-10-2016 | Insight

A ‘hard Brexit’ in which the UK puts sovereignty above access to the EU single market is the worst-case economic scenario for the country, says Chief Economist Léon Cornelissen.

  • Léon  Cornelissen
    Léon
    Cornelissen
    Chief Economist

Speed read

  • British PM says she will trigger Article 50 before end of March 2017
  • May says control of borders has priority over access to single market
  • Pound falls on fears of loss of trade and lower future GDP growth

British Prime Minister Theresa May sent the pound tumbling by saying she would trigger Article 50 of the Lisbon Treaty – the formal process for leaving the 28-nation bloc – by the end of March 2017. It follows the shock referendum in June in which 52% of Britons voted to ‘Leave’, resulting in the downfall of pro-‘Remain’ PM David Cameron.

May, leader of the ruling Conservatives, also said at the party’s annual conference that she would put national sovereignty and control of immigration above trading with the EU. This implies a hard Brexit rather than a softer variant, since staying in the single market would mean accepting cherished EU rules about complete freedom of movement of people.

“Of course this is only the declaration of an intention, so in that sense it’s not that meaningful,” says Cornelissen. “May was facing a rebellion of pro-Brexit Conservatives who were pressing for Article 50 to be triggered, so she couldn’t only insist on ‘Brexit means Brexit’ – she wouldn’t have got away with anything else this time.”

“She has said that because Brexit can take many shapes, the protection of borders and sovereignty will take priority over access to the internal market. So in other words, it’s going to be a hard Brexit. Economically this is the worst-case scenario, and that’s why the pound went down.”

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Economic risks rise

Cornelissen says the main risks to the UK economy have subsequently risen, though the outlook remains unclear until Article 50 is actually triggered.

“In the short term the fall in the pound is a boost for UK exporters, and of course the stock market likes that as well,” he says. “But in the medium term we can’t be optimistic about economic growth in the UK. The weaker pound will push up inflation, and companies won’t sufficiently compensate workers with pay rises because they will say everything is uncertain.”

‘Household incomes will suffer and GDP forecasts will come down’

“So household incomes will suffer and GDP forecasts will come down. This uncertainty will hamper foreign and domestic investment in the UK; companies will take a wait-and-see attitude before committing to anything. The longer-term outlook depends on the Brexit scenario unfolding, but a hard Brexit points to heavy losses to GDP in the coming years.”

“What helps her at the moment is that the UK economy so far has done well since the June referendum, but that will undoubtedly change in a hard Brexit scenario. And party tactics take precedence over economic logic of course.”

Back to the WTO?

Having been in what was originally the ‘Common Market’ since 1973, the future shape of UK trade without new treaties being signed also remains unknown, Cornelissen says.

“In terms of trade, a hard Brexit means falling back to World Trade Organization (WTO) rules, though there are complications with this since they were formulated within the EU context,” he warns. “Adopting WTO rules in future will mean tariffs, so the hard Brexit will come at a heavy economic price. The crucial question is whether the UK parliament is prepared to take this path. A vote against it could be forced, and a general election can’t be ruled out.”

‘We need to see what the reaction to this new hard line position will be’

The parliamentary issue may be key, since historically the UK’s lower House of Commons has held sovereignty over all other institutions, including the government, monarch and courts. Parliament must therefore authorize all government actions, from the trivial to going to war. However, the Conservatives have a slim majority of just 16 MPs over all the other parties in the 650-seat chamber, of which many are pro-EU, making a vote over Article 50 risky for May.

“You could argue that given the narrow win in the referendum, the trigger would need to be backed by the UK parliament whatever the formal powers vested in the prime minister,” says Cornelissen. “But given the narrow majority that the Conservatives have in the UK parliament, it is not surprising that the government has insisted on its prerogative on being the sole entity that can trigger Article 50, but there have been legal challenges to this point of view issued already. So what actually comes to pass at this stage is unclear; we need to see what the reaction to this new hard line position will be.”

EU will deter further exits

As far as the EU is concerned, you can be sure it will do its utmost to discourage any more exits, particularly as nationalism rises in other countries amid the ongoing refugee crisis, Cornelissen says.

“The EU will be relieved once Article 50 is actually triggered, and March 2017 is convenient for them because this would come before the French presidential election due in April and the German general election due in September,” he says.

“And remember that the EU has every incentive to make sure the UK pays a heavy economic price for leaving it. In the meantime, we can expect further pound weakness and relative euro strength. But so much depends on developments that a speech by May is really only a kind of opening move in a giant chess game.”