Fund managers are bracing for the risk of the UK economy tumbling into recession, as the stakes over the UK's exit from the European Union rise.
Prime minister Theresa May has laid out her 585-page withdrawal agreement but is battling opposition from both Brexiteer and remain MPs in trying to convince them to vote through her plan on 11 December.
Yesterday the government's own analysis warned the UK would be poorer under any form of Brexit. Official figures said that, compared to the economy's prospects if the UK economy remained in the EU, it would be around 3.9% smaller over the next 15 years under May’s plan, and 9.3% smaller under a ‘no deal’ Brexit.
A warning from the Bank of England, also delivered yesterday, was even starker: an 8% fall in gross domestic product next year, even more severe than the recession sparked by the financial crisis, under its worse-case scenario. That warning attracted criticism from some economists for being too severe.
Mark Burgess, manager of the Threadneedle Managed Equity, Equity Focused and Equity & Bond funds, agreed the UK would be shocked into recession in the event of May's deal falling through and a resulting 'hard Brexit', based on World Trade Organisation trading rules.
‘I think we will have a recession in 2019 if we have a hard Brexit,’ said Burgess. ‘Companies have been delaying their investment decisions…and they will delay further or make different decisions… I think it will shock the UK into recession.’
Burgess, deputy global chief investment officer at Columbia Threadneedle, said Brexiteers were being ‘naïve’ if they believed the EU would let the UK divorce itself from the region quietly.
‘One of the naiveties of Brexiteers is the expectation that Europe would negotiate softly and give in to our demands,’ he said.
‘There are reasons for it not to do that; Italy is looming large and if the UK emerges in good shape that would encourage others to do the same. There is contagion risk and that will play out over six to nine months.’
Burgess added that Europe would not emerge unscathed from Brexit as the UK is ‘an important trading partner’.
Trevor Greetham (pictured), head of multi-asset at Royal London and manager of its Global Multi Asset Portfolios fund range, said a no deal outcome would be the most damaging for the UK economy and would result in ‘a substantial drop in sterling’.
The opposite is the potential for a second referendum and for Brexit to be called off completely.
‘If there was no Brexit then sterling would go up a lot and the Bank could raise interest rates because growth will have recovered,’ said Greetham.
Greetham said May’s plan, or an abandonment of Brexit, currently looked like the only options on the table, even if May was forced to step down.
‘The economic reality is whoever is in charge may find if they take over, they cannot unlock parliament and find themselves in the same position as May,’ he said.
‘There is no appetite, certainly on the European side, to start negotiations again so I don’t think it matters too much whether it’s May [in charge] or someone else. The reality of the situation will mean we will very likely end up having to call a referendum or somehow get the current deal through Parliament.’
Citywire A-rated Jim Leaviss (pictured), head of retail fixed interest at M&G and manager of the M&G Global Macro Bond fund, warned that interest rate rises from the Bank of England could be a trigger for a UK recession.
In the Bank's analysis released yesterday, it predicts inflation surging to 6.5% under a worse-case scenario, sparking the need for interest rate rises.
Leaviss said the Bank of England was unlikely to ‘do anything substantial’ before Brexit negotiations were finalised. He believes that just a 1% rise in rates could push the UK into recession.
‘We are a consumption based economy and two-thirds of growth is consumption, and we have a lot of people on floating rate mortgages, and an increase has a big impact at a low level,’ said Leaviss.
He said the average mortgage rate was 3% and even if homeowners were on a fixed mortgage, the terms were typically five years at most, meaning any move up in interest rates ‘will feed through over a short period of time’.
This coupled with a zero savings rate in the UK could spell disaster.
‘If rates wind up 1% in the UK, we would see a dramatic recession,’ said Leaviss. ‘If you have a £600 per month mortgage and rates go up 1% then that is a one-third increase at a time when savings rates are zero.’
He said the Bank of England was ‘petrified’ of raising rates.
‘They will be nervous about inflation and wage rises that will feed through… and if we have another inflation shock, they would have no choice but to hike rates, but not by too much.’
Although the financial crisis was still fresh in people’s minds, it has not curbed borrowing and Leaviss said debt was ‘way higher than it was going into the crisis’, for banks, corporates, government, and households.
‘We have more debt going into this than before but… how long can interest rates go up and to where without causing another accident in the global economy?’