The lockdown response to the spread of Covid-19 has hit the UK economy hard. GDP could shrink by around a quarter in Q2 and continued social distancing means any recovery in the second half of the year won’t be instantaneous. As in other countries, the kind of recovery we get largely depends on the course the disease takes from here. If we can contain the disease after lockdown is eased – if the reproduction rate (R) remains below 1 – then a ‘V’-shaped recovery remains possible. If however, there is a second wave and lockdown is reintroduced, then a ‘U’ or a ‘W’-shaped recovery is more likely. We could also get a ‘U’ or a ‘W’ if financial market turmoil restarts. Finally, if lockdown or social distancing results in widespread bankruptcy, capital and demand destruction then we may never get back to the pre-crisis trend path – an ‘L’-shaped ‘recovery’. In truth, we don’t know which of these is going to happen, but we assign a 35% probability to the ‘V’, 35% to the ‘U’ or ‘W’ and 20% to the ‘L’.
Understandably, against this background Brexit has taken a bit of a back seat. And, in truth, the size of this Coronavirus shock puts some of the more alarmist talk about the economic cost of Brexit into perspective. Some estimated Brexit might cost the UK economy up to 9% of its GDP (relative to a growing trend) over 15 years. I always felt those predictions were way too pessimistic, but in any case the virus will have inflicted around three times that cost in the space of one quarter. The key short-run decision is whether either UK or the EU should seek an extension to the transition period beyond December 31st this year, effectively keeping the UK under EU jurisdiction for longer. The UK government is adamant it will not do that, given the mandate it received at the last general election. It argues that, by seeking an ‘off-the-peg’ Canada-type trade deal, an agreement ought to be negotiable by the end of the year. Other commentators think that is optimistic, especially since the EU is intent on sticking to its ‘level-playing field’ and fisheries asks.
Given that government resources have understandably been diverted away from Brexit and ‘no-deal’ planning, while both sides seem to be sticking to their negotiating guns and an extension looks unlikely, then the chances of a ‘no deal’ Brexit at the end of the year have gone up. I was always more sanguine about the economic costs of that than many of my economist colleagues, but in any case the impact of ‘no deal’ is likely to pale by comparison with what we are currently going through.
Shamik Dhar, chief economist, BNY Mellon Investment Management.