U.K. Economy Still Faces Trade Pain After Dodging No-Deal Brexit

(Bloomberg) -- Britain averted the damage of a complete breakdown in formal trade ties with the European Union, but it’ll still confront the biggest reset of an advanced economy’s commercial relations since World War II.

The 11th-hour pact clinched by Prime Minister Boris Johnson on Thursday allows the final phase of Brexit to proceed with a relatively orderly divorce on Jan. 1.

The U.K still faces a rude awakening though, as a new customs regime of form-filling and monitoring ends the seamless trade arrangements that have been in place since the 1970s. That risks disruptions at ports and even food shortages in supermarkets, while bottlenecks could immediately translate into softer economic growth and higher prices.

The agreement avoids the shock from a no-deal, which Bloomberg Economics had forecast would knock an additional 1.5% off output in 2021 as tariffs took effect, deepening an expected recession from the latest coronavirus restrictions. Yet longer term, the new frictions mean growth is forecast to be 0.5 percentage point lower a year for the next decade than if the U.K. had stayed in the bloc.

The country got a taste of potential chaos this month, when France shut down cross-Channel traffic because of the escalation of the virus outbreak in the U.K. That left thousands of trucks backed up on roads outside the port of Dover.

Britain will at least enjoy a tariff-free cushion for its manufacturers as they trade with a market that currently buys more than 40% of the country’s exports. But that comfort eludes the bankers, architects and consultants in its lucrative service industry -- they weren’t part of the accord.

New immigration rules are also set to replace free movement of people, making it trickier to hire experienced labor from abroad. Foreign investment could suffer once the U.K. no longer offers simple access to the EU’s single market, which has long been a major incentive for companies.

Just this month, Nissan Motor Co., which had been considering its Sunderland plant for its new electric vehicle, opted instead to make it in Japan.

Citigroup Inc.’s Benjamin Nabarro said in a report that the new deal constitutes “threadbare access combined with fewer medium-term assurances” that will weigh heavily on U.K. growth over the coming years.

Economic Destiny

The Brussels agreement closes a chapter on a rare period when voters were granted full consent in a referendum to determine the U.K.’s economic destiny.

Four and a half years on, the economy will start weathering the challenges of the 21st century alone, less able to access the opportunities of its biggest and closest trading area, but also less constrained by its rules.

The gamble that such a break will pay off in the long run is what Johnson is wagering. The government will likely now set off on a series of bilateral negotiations over trade deals, with the U.S. among the priorities. It will have more power over regulations and taxes, which it can use to help businesses.

Any near-term economic pain will be overshadowed in any case by the immediate bounce from a year of unprecedented shutdowns to contain the coronavirus outbreak.

The U.K. economy is set to grow more than 5% in 2021 as it rebounds from the huge slump forced by the pandemic, according to economist forecasts compiled by Bloomberg earlier in December -- though Covid-19 restrictions may mean there is a downside risk to those numbers.

The accord also lessens the urgency for more emergency fiscal or monetary stimulus to cushion any blow. The Bank of England already cut its benchmark interest rate to 0.1% and resumed bond-buying this year to help the economy through the pandemic.

Still, BOE Governor Andrew Bailey has been blunt about the limited upside from an agreement, saying there’s “no such thing as a frictionless deal.”

While no-deal would have been worse -- crushing parts of Britain’s dwindling manufacturing sector -- the poorer commercial relations with continental Europe, as well as slower population growth due to tighter immigration, will probably leave the U.K. on a lower growth path for much longer.

A weaker pound may provide some support by making exports cheaper. Sterling never fully regained its initial losses in the aftermath of the 2016 vote, reflecting persistent uncertainty.

But that uncertainty has also translated into feeble business investment, which has grown well below the levels seen in the U.S., Germany and France.

The situation could yet worsen. A study by University College London and the London School of Economics forecasts that foreign investment into the U.K. could drop 37% post-Brexit.

Despite the finance industry accounting for about 7% of Britain’s economy and more than 1 million jobs, the issue of its access to the EU was left out of negotiations for a free-trade agreement. Other services professions face a similar fate.

A number of major banks, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., have already been making plans to shift some operations from London to the continent. Whether that trickle becomes a flood could become one of the more critical economic tests of Brexit’s success in coming years.

©2020 Bloomberg L.P.