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Brexit and the EU Eurozone 2 September 2019 Economics Brexit and the EU Eurozone Implications of 'no deal' for the eurozone The clear gap between the UK and EU negotiating positions means a 'no deal' Brexit is a real possibility While we do not think a disorderly Brexit will cause a recession in the eurozone, nor even in Ireland… …it would likely weigh on already lacklustre growth prospects and could raise calls for the ECB to scale up QE 'No deal' a real possibility UK Prime Minister Boris Johnson has pledged to leave the EU 31 October "do or die". As we outline in a box on page 4, we see little incentive for the EU to meet Mr Chris Hare Johnson's demand to remove the Northern Ireland 'backstop', meaning the prospect of Economist a deal still looks fragile. And, with limited time for the UK Parliament to block 'no deal', HSBC Bank plc [email protected] it is perhaps unsurprising that the bookmakers see a roughly 40% chance of it. +44 20 7991 2995 Fabio Balboni What would a potential 'no deal' look like? Senior Economist It is impossible to predict the precise arrangements that would be established HSBC Bank plc [email protected] between the UK and the EU under a potential 'no deal'. But on the whole, we follow +44 20 7992 0374 the 'disorderly no deal' assumptions outlined in our 'no deal' analysis of the UK Chantana Sam (Brexit Strategies: No deal for real? 27 June 2019). This includes immediate trade Economist HSBC France tariffs and trade disruption relating to border checks, but more benign transition [email protected] measures for (financial) services trade. +33 1 40 70 77 95 Rainer Sartoris, CFA Weaker growth, lower inflation, looser policy Economist HSBC Trinkaus & Burkhardt AG In this context, we construct a scenario for eurozone growth and inflation under 'no [email protected] +49 211 910 2470 deal'. Bearing in mind that eurozone exports to the UK are worth just over 3% of its Shanella Rajanayagam GDP, we consider spillovers from: (i) trade disruption (ii) a possible UK recession (iii) Trade Economist weaker UK demand due to a likely fall in the pound (iv) confidence effects (v) banking HSBC Bank plc [email protected] sector spillovers. Taken together, a 'no deal' Brexit would knock 0.3ppts off eurozone +44 20 3268 4118 growth in 2020. A small, slow-burn drag on trade and GDP might well persist beyond that. And inflation might be a touch softer, too. As a central case, then, we assume a relatively mild impact of 'no deal' Brexit for the eurozone as a whole. But the impact could be bigger, particularly if financial conditions tighten. And in any case, we think 'no deal' might raise calls for the ECB to scale up its QE programme, versus our EUR30bn a month central case. There might be a fiscal response, but perhaps only limited to the most affected sectors. Meanwhile, as we outline in a box on page 15, a tussle over the 'Brexit divorce bill' lies ahead. Finally, from page 16 onwards, we outline scenarios for the Big 4 eurozone countries and Ireland. While the likely impact on the Big 4 might be broadly similar to that on the eurozone as a whole, Ireland would likely see by far the biggest hit. But even there, strong fundamentals should help avoid a recession, in our view. Disclosures & Disclaimer Issuer of report: HSBC Bank plc This report must be read with the disclosures and the analyst certifications in View HSBC Global Research at: the Disclosure appendix, and with the Disclaimer, which forms part of it. https://www.research.hsbc.com Economics ● Eurozone 2 September 2019 'No deal' for real? The clear gap between the UK and EU negotiating positions means 'no deal' Brexit is a material possibility While we do not think a disorderly Brexit will cause a recession in the eurozone, nor even in Ireland… …we do think it would lead the ECB to ramp-up stimulus, and might lead some countries to consider fiscal loosening 'No deal' has become more likely Since Boris Johnson became the UK's Prime Minister in late July, the chances of a 'no deal' Brexit have risen. Mr Johnson has pledged to remove the UK from the EU on 31 October "do or die". We are getting ready to come out on 31 October… do or die. Come what may. UK Prime Minister Boris Johnson, 25 June The problem is, it is difficult to see how a deal can be agreed to by the EU, the UK government and the UK parliament by then. Mr Johnson has called for a complete removal of the Northern Ireland 'backstop' from the UK's Withdrawal Agreement. It is very unlikely that the EU would go far as that, in our view. Nor do we think it likely that the UK will devise alternative solutions (to the satisfaction of the EU) to supersede the backstop by late September, as suggested by German Chancellor Angela Merkel.1 We do think the EU could agree to tweaks to the Withdrawal Agreement which could bring a majority of UK MPs onside, but that is by no means guaranteed. Moreover, particularly following the government's announcement that it will prorogue (shut down) parliament between mid-September and 14 October, there are limited opportunities for MPs to block 'no deal' (see Brexit: Season finale? Ten questions and answers, 30 August). The bookies are pointing to a Bearing this impasse in mind, it is perhaps unsurprising that the bookmakers' odds are pointing roughly 40% chance of 'no to a 40% chance of 'no deal' Brexit by the end of the year (Betfair, 29 August). deal' Brexit this year ______________________________________ 1 'Boris Johnson accepts Angela Merkel challenge to replace Irish backstop in 30 days', The Independent, 21 August 2 Economics ● Eurozone 2 September 2019 What would 'no deal' look like? This June we published a report on the possible impact of 'no deal' Brexit on the UK (Brexit Strategies: No deal for real? 27 June 2019). It is impossible to say precisely what a potential 'no deal' would look like. Indeed, even after a 'no deal', the UK and the EU could soon come back to the negotiating table to hammer out a deal, thereby limiting economic fallout. But assuming that doesn't happen, we highlight some assumptions underlying the trading relationship in more details in Table 21 in the Appendix (page 24). We think key elements of potential 'no deal' Brexit would be as follows: The EU immediately imposes WTO tariffs on imports from the UK: The EU's average non- preferential tariffs rates stand at 12% for agriculture and 4.2% for non-agriculture. The UK immediately applies a 'temporary' tariff regime, first outlined in March 2019: This would leave most UK tariffs on industrial goods imports from the EU at zero. But the EU would face higher UK tariffs on imports of cars and certain agricultural goods compared to current arrangements. Significant border disruption: In particular, this would involve the EU rapidly imposing customs and regulatory checks on imports from the UK at its ports. On the other hand, the UK appears to be signalling a more gradual imposition of checks. Uncertainties around the Northern Irish border: We do not envisage border infrastructure being established, at least in the first instance. But without the establishment of some form of comprehensive border arrangement, some form of behind-the-border checks, alongside significant uncertainty, is likely, in our view. The UK will not impose any tariffs or new border checks temporarily on Northern Irish imports from the Republic of Ireland. Limited shock to financial services: The UK authorities plan to give EU financial institutions continued 'passporting' rights to the UK for three years under 'no deal'.2 EU arrangements for UK firms are more piecemeal, though, which is a risk to EU27-based consumers of UK financial services. Citizens' rights broadly intact: Even under 'no deal', we find it highly unlikely that the rights of EU citizens living in the UK, and vice versa, would be curtailed to the extent that would spark a big one-off migration. But over time, migration flows, particularly of unskilled workers, are likely to slow. There is a risk, though, that the adjustment might come more quickly, given reports of UK government plans to end free movement of EU citizens from 1 November. EU citizens already residing in the UK might face residency issues if they have not applied for 'settled' or 'pre-settled' status in the UK.3 Other forms of disruption: There are a range of other possible forms of disruption not covered above. For example, while an agreement has been signed to keep planes flying between the UK and the EU, many other agreements would likely be needed to prevent disruption in other areas, ranging from medicines, to fisheries, to data protection. ______________________________________ 2 'The temporary permissions regime for inbound passporting EEA firms and funds', fca.org.uk 3 'UK to end freedom of movement for EU citizens on day one of Brexit, under new government plan', The Independent, 18 August 3 Economics ● Eurozone 2 September 2019 Box: Between a backstop and a hard place The UK wants to remove the backstop… The chances of 'no deal' Brexit mostly reflect the state of play on the Northern Irish 'backstop', which forms part of the UK/EU Withdrawal Agreement. The backstop outlines that, after a post- Brexit 'status quo' transition period, if no alternative plans can guarantee a 'soft' border between Northern Ireland and the Republic of Ireland (RoI) (i) the whole of the UK needs to remain in the EU customs union (ii) Northern Ireland to remain in the EU's single market for goods trade.
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