Since Britain voted to leave the European Union, the economy has held up far better than almost every single economist and forecaster predicted.
Other than the crash in the pound, the doom-laden predictions surrounding immediate recessions and instant massive capital flight that came prior to the vote have failed to materialise, and the UK’s economy has shown remarkable resilience.
Most major forecasters now expect Britain to keep growing despite the Brexit turmoil, and for any recession to be avoided (with the notable exception of Barclays).
Among those forecasters is Goldman Sachs — which initially predicted a recession in the UK in the event of a Leave vote, but has since rowed back, and now expects steady, if lower than pre-Brexit, growth.
Goldman released its latest European Economics Analyst note on Wednesday, including a detailed analysis of the bank’s forecasts for the coming three years across Europe. Within its analysis, Goldman provides what it calls its “alternative scenario” for the British economy going forward.
This is essentially a near-doomsday set of circumstances for Britain following a big “shock to institutional confidence,” because of Brexit. In the scenario, sterling crashes again, the Bank of England raises rates to 1.25%, and Britain is forced to resort to a brutal deficit reduction programme. As analyst Adrian Paul writes:
“(i) trade-weighted Sterling suffers a one-off 10% depreciation (not dissimilar to the ERM Crisis), (ii) the BoE can no longer ‘look through’ the resulting inflationary consequences (Bank Rate is hiked by a cumulative 100bp over the subsequent year) and (iii) the current Chancellor resorts to the former Chancellor’s pre-referendum plans for fiscal consolidation.”
“A loss of confidence in UK institutions has three implications: (i) the shock to the currency boosts inflation by more than it cushions growth, (ii) the monetary policy impulse turns contractionary and (iii) the fiscal tightening constricts activity.”
“All in all — notwithstanding a considerable tightening of monetary and fiscal policy — the shock to institutional confidence in our alternative scenario pushes annual CPI inflation to a peak of 3½% in mid- 2018 (compared with a 2.9% peak in our baseline). Three years ahead, the shock implies a level of UK GDP which is 1¾% lower than our baseline, and a price level which is 2% higher.”
The chart below illustrates the potential impacts:
Goldman is clear that its alternative scenario is just that, an alternative, and it expects the far more likely “baseline” outlook to prevail. In that situation, GDP growth will sit around 2% lower than expected prior to the referendum by the end of 2019. Immediately after the Brexit vote, that number was roughly 2.75%.
“To be clear, our baseline outlook for the UK economy (described in the main text), is one in which investor confidence (both foreign and domestic) in the UK’s institutional framework is preserved,” the note says.
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