The Office for Budget Responsibility (OBR) painted a bleak picture where a failure to reach a free trade agreement with the EU will “compound” the massive economic impact of Covid, which in 2020 caused the biggest fall in economic output in 300 years (11%).
The prime minister’s team is currently locked in trade negotiations with the EU with just days left to reach a deal as the end of the standstill transition period looms on December 31.
In its economic outlook accompanying chancellor Rishi Sunak’s spending review, the OBR forecast that Brexit alone would cause a 4% long-run hit to output even if Johnson does strike a deal.
But a failure to reach agreement and defaulting to World Trade Organisation (WTO) terms, including tariffs on trade with the EU, would add up to 2% to this, meaning a long-run hit to economic output of up to 6%.
This would “have the effect of delaying the point at which output regains its pre-virus peak by almost a year to the third quarter of 2023”, under the watchdog’s “central” forecast.
The introduction of tariffs and other barriers to trade between the UK and EU, would translate to a long-term hike in prices for UK consumers of 1.5% by 2026, caused by the introduction of tariffs and a tanking of the exchange rate.
In the short-term, unemployment will also be 0.9% higher under no deal, peaking at 8.3% in summer next year, while recovering over the medium term.
There will also be a double whammy effect with sectors that have fared okay during the pandemic such as manufacturing and financial services facing the biggest hit from a no-deal Brexit as they are “most exposed to the loss of unfettered access to the EU market”.
The short-term impact of no deal will depend on how prepared the government and businesses are to manage new requirements.
But the watchdog noted that both have been “distracted by the need to deal with the disruption caused by the virus” – taking up personnel and resources while also running down cash reserves and inventories and “making them more vulnerable to shocks”.
As well as the temporary disruption of no deal, defaulting to WTO terms would lead to a “longer-term impact on the productive potential of the UK economy”.
Trade deals with major economies including the US, which are often trumpeted by Brexiteers, will only have a “modest impact” relative to EU membership.
While trade agreements already struck with the likes of Japan “do not provide any benefit relative to being a member of the EU” as they simply replicate existing terms.
The imposition of tariffs would see the UK rake in £6bn more in customs duties every year.
But it would be “more than outweighed” by the £14bn overall reduction in tax revenues from a smaller economy and by 2025-26, overall revenues would fall by £6bn, the OBR said.
The watchdog said: “The uncertainty created by the pandemic is compounded by the presently unresolved nature of the UK’s future trading relationship with the EU after the transition period ends on December 31.
“Our three scenarios all assume that the UK makes an orderly transition to a typical free-trade agreement (FTA).
“This new trading relationship is expected to lead to a long-run loss of output of around 4% compared to remaining in the EU, which was already incorporated into our March forecast.
“But given the continued uncertainty over the outcome of the Brexit negotiations, we also include a scenario in which the UK’s trading relationship defaults to WTO terms on January, with some accompanying short-term disruption. This would further reduce output by 2% initially and 1.5% at the forecast horizon.”
Meanwhile, the OBR’s central forecast was based on the assumption that the UK would remain at the level of pre-lockdown tier 3 coronavirus restrictions until spring, raising concerns among backbench Tory rebels that this is what the government is planning for.