Will the decision by UK voters to exit the European Union result in a self-inflicted recession? We find out.
According to all the research we have seen in response to the EU referendum result a notable slowdown in UK economic growth is coming.
The impact of Brexit on the business community is likely via the uncertainty that negotiating a new trade relationship with our biggest trading partner - Europe - entails.
There should be notable shifts in the trade relationship with the all-important services sector likely to be an area that is particularly vulnerable.
This is because the trade of goods is relatively straightforward, however the trade in services, e.g banking and financial, is a great deal more complex.
For instance, we hear HSBC is already looking to move staff to Europe while the European Banking Authority is said to be in the process of leaving London.
The big question though is how deep the decline in growth will be - will the UK fall into recession or will we be entering a period of anaemic growth?
Technically, a country must experience two successive quarters of GDP decline to be considered in recession.
According to post-Brexit forecasts issued by Barclays, the UK will indeed see negative growth in the third and fourth quarters of 2016 in which -0.1% growth is forecast.
Growth is forecast to turn positive in early 2017 once again, ensuring the recession ends.
Barclays have also updated forecasts showing that UK inflation will rise rapidly over coming months as a weaker exchange rate pushes up the cost of imports.
Neville Hill at Credit Suisse says he is predicting a shallow recession in the UK in the second half of the year, with GDP falling by just over 1%.
“That should be driven by a halt in business investment as firms react to the uncertainty relating to triggered by the vote; and a squeeze in consumer spending as a consequence of currency depreciation and higher inflation,” says Hill.
Credit Suisse have cut GDP forecast for this year to 1.0% from 1.8% and our 2017 forecast to -1.0% from 2.3%.
“The UK has taken a significant step back from globalisation. That’s a trend gaining political support across the west. Such a significant secular shift has the potential to have substantial implications for growth, corporate profits and asset prices in the medium term,” says Hill.
Credit Suisse now expect rates to be cut to 0.05% from 0.5% and another round of quantitative easing, of £75bn.
“We expect those measures to be announced by the 4 August MPC meeting at the latest. If financial markets and cyclical data are sufficiently weak, a move as soon as the 14 July meeting is possible,” says Hill.
Depth of Recession Depends on Capital Inflow Response
The response of capital flows into, our out of, the UK will be key in determining whether a shallow recession becomes something deeper and uglier.
As of the end of last year the UK had a current account deficit of 7% of GDP, one of the highest in the developed world owing to our reliance on imports.
However, the deficit is patched over by foreign investment inflows which have kept the pound at the levels we have been used to over recent years.
Most of that was financed by net foreign direct and portfolio investment flows.
As we have noted before, the current account deficit is arguably the channel via which the GBP has most to lose.
Were foreign investor inflows to dry up, then the GBP/EUR could actually fall to parity say UBS.
Credit Suisse agree suggesting that if those flows were to slow markedly, or even reverse, then the pressure for the current account deficit to close materially would be considerable.
“That would manifest itself in a disorderly depreciation of sterling sufficient to force monetary and fiscal policy to tighten and squeeze domestic demand,” says Hill.
“That would mean higher, not lower, policy rates and a materially deeper recession than the one we expect. As such, this a risk to our central view.”
JP Morgan Downgrades Forecasts, But See No Recession
Investment bank JP Morgan have revealed their latest post-Brexit forecasts.
A look at the GDP numbers shows that while downgrades have been made, two successive quarters of negative growth are seen.
Third quarter 2016 GDP growth remains at +1% however the final quarter's growth is downgraded to 0.5%. The first quarter for 2017 is also downgraded to 1%.
However, the Bank of England is forecast to implement two 25 basis point cuts to the basic lending rate before the year-end, which should prove supportive to the economy.
This is likely why they have upgraded their inflation forecasts to 1.1% for the final quarter of 2016 and to 2.2% for the second quarter of 2017.
Capital Economics: Response by Bank of England will be Key
Striking a more positive tone are Capital Economics, the organisation headed by Woolfson prize winning Roger Bootle.
Capital Economics argue that the most pessimistic forecasts for a post-Brexit UK do not take into account the stimulatory response of policymakers and politicians.
“One factor which will have an important influence on just how damaging those consequences are will of course be the response of the policymakers. Recall that much of the more pessimistic analysis of the impact of Brexit, including the Treasury’s, did not incorporate any offsetting policy response.”
“A robust response from the Bank of England, which will probably reduce interest rates, perhaps to as low as zero, and may even launch a fresh batch of quantitative easing.
“Against this background, we now expect at least one cut in Bank Rate to 0.25% and would not rule out a drop to zero. Meanwhile, there must be a good chance of a ramp-up of the MPC’s asset purchase programme, while further sharp falls in the pound could prompt the Committee to use its FX reserve pot for the first time to at least smooth the currency’s path.”
Either way, if current fiscal and monetary settings were left as they were the UK would fall into recession.
Therefore, it is all eyes on the Bank of England it seems,