Economists at Morgan Stanley argue that if the British government manages to secure a so-called “Goldilocks Brexit,” which manages to satisfy all parties, the UK’s economy could avoid any substantial damage from leaving the European Union.
Writing in a note entitled “Spending Until Squeezed” on Thursday, Morgan Stanley’s UK economics team argue that while the most likely economic outcome of Britain leaving the EU will be a gradual slowdown over the coming years, a just-right deal could mean no ill effects to UK PLC.
“Sustained resilience would likely require a ‘Goldilocks’ Brexit, we think,” Jacob Nell and Melanie Baker write.
This sort of deal may be unlikely, but it is possible, the pair argue, saying: “There is a chance that the UK consumer will continue to purchase at a similar pace for an extended period. The Brexit-related headwinds may be much weaker than we expect — although this would likely require the unfolding of an unexpectedly gentle Brexit.”
There are four key areas where Nell and Baker see as potentially influencing the robustness of Britain’s economy once the Brexit ball is rolling.
“First and foremost,” they write “job losses may be much milder/drawn out than even in our modest central case. Actual Brexit is more than two years away, potentially delaying most of any structural change that could bring job losses in some sectors. The impact of the weaker currency on inflation may be weaker than we anticipate. That would leave several tailwinds dominant and help to keep consumer spending growth elevated.”
Next up, is how growth in wages progresses as Brexit talks start. Here are Nell and Baker once again:
“We see upside risks to our pay growth forecast for several reasons: 1) The National Living Wage is set to rise another 4.2% in April.2) With the UK close to full employment workers may demand (and be granted)higher pay growth than in our central case to compensate for higher inflation.3) We could see a sharp fall in net migration (e.g.as a result of the weak GBP, perceptions of a more hostile UK and improving labour market conditions in the rest of the EU), tightening the UK labour market further.”
It is worth noting, as Morgan Stanley does, that if wage growth does continue strongly it could force the Bank of England to increase interest rates to stop the economy overheating. This would have impacts on “some of the positive effects for aggregate consumer spending.”
Consumer spending, and therefore the wider economy, could also be propped up by the fierce price war raging between traditional British supermarkets like Tesco and Sainsbury’s, and German interlopers Aldi and Lidl, who offer goods at significant discounts to the old guard. Here is Morgan Stanley again:
“That suggests significant scope for households to save money on their grocery shopping at least (especially given that, since the last big batch of currency depreciation in 2008, the number of Aldi/Lidl stores has risen by ~59%. The chances of having an Aldi or Lidl close by are substantially higher now). There is also room for shoppers to ‘trade down’ within store, e.g. moving to cheaper ranges for part of their shop.”
They do not suggest that this will definitely occur, but if it does, “consumer spending can hold up well in volume terms despite higher inflation.”
Finally, Morgan Stanley’s economists suggest that there is definitely scope for credit conditions in the UK to loosen further, with Britain’s lenders likely to keep lending even in the scope of a downturn, thanks to tough post-financial crisis regulations.
“Banks are vastly better capitalised than in the pre-GFC period. They are now more able to weather a downturn before needing to sharply draw in domestic credit availability,” Nell and Baker say.
Morgan Stanley makes it pretty clear that it sees the “Goldilocks” Brexit — named for the fairy tale when the character of the same name tries out porridge and beds in a house of bears to find the conditions that are “just right” — is pretty unlikely, especially given that Prime Minister Theresa May seems to favour a “hard Brexit.” It is nonetheless, an interesting thought experiment.
In the same note, the bank, one of the world’s biggest, also said that it is “eating humble pie” about its post-Brexit economic forecasts.
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