An intensification of political divisions within the UK and slow progress in negotiations with the EU means there is such a wide range of potential Brexit outcomes that no individual scenario has a high probability, Fitch Ratings says.
We no longer believe it is appropriate to identify a specific base case. An acrimonious and disruptive “no deal” Brexit is a material and growing possibility.
Fitch’s prior base-case assumption following the 19 March draft withdrawal agreement – that the UK would leave the EU in March 2019 with a transition period until around December 2020 and a framework for a future Free-Trade Agreement – looks more uncertain. This scenario no longer ranks as significantly more likely than other possible outcomes.
The UK government’s 6 July plan faces opposition from ‘remainers’ and ‘brexiteers’ and has led to close parliamentary votes on Brexit legislation, underlining the depth of division within the ruling Conservative Party and parliament on the future relationship with the EU. Any deal is likely to provoke brinkmanship and may not gain parliamentary approval. This could trigger a general election and greater talk of a second referendum.
The time available to finalise a withdrawal agreement is getting shorter, while the UK and EU remain wide apart. The European Commission has expressed fundamental concerns on aspects of the UK plan. Without more EU flexibility on the indivisibility of the four freedoms (goods, capital, services, and labour), in the context of no physical Irish border, this implies the UK would need to abandon red lines regarding free movement of people and the jurisdiction of the European Court of Justice. Such concessions would make it even more difficult to secure parliamentary passage for a Brexit deal.
Potential outcomes include the UK leaving the EU in March, with a transition agreement and a framework on future trade relations. These range from something based around the UK’s 6 July plan, to initial WTO terms with a commitment to seek a future free trade agreement, to closer alignment with the EU through Single Market and/or Customs Union membership.
“No deal” is also a material possibility. This would substantially disrupt customs, trade and economic activity, with the depth of disruption depending on how quickly a “bare bones” deal could be reached.
Extending the withdrawal period is a more remote possibility, requiring unanimous approval by the European Council in agreement with the UK government. The UK remaining in the EU cannot be excluded if there is a second referendum. As things stand, in our view, no single outcome has a high probability.
Political, economic and institutional uncertainty stemming from the negotiations is reflected in the Negative Outlook on the UK’s ‘AA’ sovereign rating. An outcome that adversely affected growth prospects could lead to a downgrade, as we said when we affirmed the rating in April. Political developments that impede a clear determination of the UK’s future relationship with the EU or undermine the economic policy framework and economic performance are also negative rating sensitivities.
Our most recent macroeconomic forecasts point to GDP growth slowing to 1.3% this year. We forecast stronger growth of 1.7% in 2019 and 2020, in line with the UK economy’s potential growth. But this assumes a smooth Brexit. In a more disruptive Brexit we could substantially reduce our growth forecasts and change our unemployment and inflation assumptions.
Our current forecasts are consistent with the general government deficit falling moderately to 1.4% of GDP in 2020 from 1.9% in 2017, allowing government debt-to-GDP to decline to 83.5% from 87.7%. An adverse Brexit scenario involving a sharp growth slowdown in 2019 and anaemic recovery in 2020 could see the deficit rise towards 2.5% of GDP in the near term, other things equal. In this scenario, debt-to-GDP would decline more gradually over 2019 and 2020.
A severe enough shock could reverse the downward trajectory in the ratio since 2015. Worsening public finances leading to a rising government debt ratio could also lead to a downgrade of the UK.
