IMF Raises 2016 UK Growth Outlook, but Lowers 2017 Forecast

By Grace Shi ’19

The International Monetary Fund (IMF) upgraded its 2016 GDP growth outlook for the UK, but lowered its 2017 forecast, claiming that uncertainty surrounding the country’s economic future and its ties with the European Union are likely to exert a long-term drag on growth.

Britain voted in June to leave the EU. Before the referendum, the IMF predicted 1.9% growth in 2016 and 2.2% growth in 2017. In July, the Fund lowered both estimates to 1.7% and 1.3%, respectively. On Sunday, British Prime Minister Theresa May announced that Britain will invoke Article 50 by March 2017, which will notify the EU of Britain’s formal exit from the Union. The latest IMF forecast on Tuesday predicts a 1.8% growth in 2016, but only a 1.1% growth in 2017.

The rise in the 2016 forecast reflects economic data that suggests the UK has weathered the aftermath of the referendum surprisingly well. The services sector—which makes up almost 80% of the UK’s economy—grew 0.4% in July. This is well above the market expectation of 0.1%. These results reflect the phenomenon that UK consumers were less cautious and more willing to spend, despite the referendum.

Actions taken by the Bank of England following the vote—including cutting interest rates to a record low of 0.25%—helped to maintain consumer confidence in the economy. The stimulus package also incorporated a new term-funding program for banks, which offered cheap loans to households and businesses. These measures made it easier for consumers and firms to borrow money for investments, avoiding the possibility of a recession predicted by economists.

Nevertheless, economists expect consumer confidence to tank. Uncertainty over the future trade and immigration relationships between the UK and the EU will likely lead to a decline in business investments and hiring.

The British Conservative Party has advocated a “hard” Brexit aimed at maintaining maximum sovereignty. This option would allow Britain to make its own trade negotiations and decide how to control immigration.

However, the UK cannot fully benefit from the EU’s single market—which eliminates tariff barriers—without abiding by the EU’s laws—which includes free movement of people and paying into the EU budget. Norway and Switzerland are outside the EU, but abide by the EU’s laws to gain access to the single market. If Britain follows these countries, it will negotiate a “soft” Brexit.

Since Britain has opted for more autonomy, the alternative is to take an outsider country position, like the US. Although the US isn’t subject to free movement of people, nor does it make payments for the EU budget, it is subject to trade barriers. The upside is that the US can negotiate its own trade relationships. If Britain pursues this option, it can partner with more dynamic economies, like those in Asia, and seek trade deals with Canada (which the EU has failed to do for the past six years).

This option also has its drawbacks. Britain’s banking industry—which contributes as much as 8% of the GDP—will be unable to passport services across Europe as efficiently. Because the EU accounts for 44% of Britain’s exports, barriers will hurt the the British economy, at least within the few years following negotiations.

While the other EU countries will not allow Britain to reap the benefits of the single market without accepting obligations, these countries understand that Britain is still a strong European nation. The EU depends heavily on British import demand. The UK is also an integral to the region’s security interests, brining stability to the Western alliance.

Although it’s clear that growth in the UK will slow due to uncertainty and the initial costs of Brexit, it remains to be seen how much freedom the country is willing to forgo for trade negotiations and how much the EU values its current relationship with the UK.

Sources:

http://www.wsj.com/articles/imf-raises-u-k-growth-forecast-for-this-year-but-lowers-outlook-for-2017-1475586005

https://www.ft.com/content/7418c482-8988-11e6-8cb7-e7ada1d123b1

http://www.telegraph.co.uk/business/2016/10/04/imf-rows-back-on-brexit-warnings-as-uk-poised-to-become-fastest/

https://www.theguardian.com/business/2016/sep/30/uk-economic-growth-what-the-economists-say

http://www.wsj.com/articles/bank-of-england-cuts-key-interest-rate-to-new-low-1470309155

http://www.wsj.com/articles/pro-brexit-economists-see-growth-opportunities-for-the-u-k-1470077709

http://www.economist.com/blogs/economist-explains/2016/10/economist-explains-3

http://www.forbes.com/sites/johnmauldin/2016/07/10/heres-how-much-europe-depends-on-the-uk/2/#5a349a072c56

Filed in: Economy

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