NIESR revises down 2017 world and UK economic growth in wake of Brexit

World economic growth has been revised down in 2017 in a large part due to Brexit, as the UK is expected to experience a marked economic slowdown beginning in the third quarter of this year.

The National Institute of Economic and Social Research (NIESR) said it expects the UK gross domestic product (GDP) to grow by 1.7% in 2016, slowing to just 1% in 2017.

As the effects of this spread out, the world economy will still grow 3% in 2016, but expectations for 2017 growth have been revised down to 3.3% from 3.5% due to the UK voting to leave the European Union.

NIESR said the likely economic pact the UK will achieve through negotiations with the EU will be the Swiss model, where the UK will have a free trade agreement with the trading block with free access to goods and markets, but limited access to service markets.

This will have a negative effect on the dominant financial sector of the UK leading a ‘balkanisation’ of EU wholesale finance.

The ‘balkanisation’ of EU finances when many large EU banks are fragile, in particular the Italian banking systems, would test the viability of the single rulebook.

Europe had the largest downward revision as growth is expected to be 0.4% lower. Growth in the eurozone was revised down to 1.3% from 1.7%.

NIESR director of microeconomics Angus Armstrong added: “Our highest value added in exports is concentrated in four key services. Both financial services and digital services need to be recognised as equivalent by the EU. This creates something of a regulatory sword of Damocles over two of our most successful export sectors.”

NIESR said the UK was more likely to rejoin the European free trade association (EFTA), which is outside the customs union. The UK co-founded EFTA in 1960 as an alternative to the European economic community (EEC), which became the EU.

Post-Brexit, the UK will have two multiple sets of negotiations, first with the World Trade Organization (WTO) and have to agree terms with the other 160 member states, as will the EU, because its terms would also have changed. Second with the EU, third with other member states, as the EU has a 53 trade agreements with other states, and lastly through the possible Transatlantic Trade Investment Partnership (TTIP).

Armstrong added: “Re-joining EFTA is consistent with the notion of ‘taking back control’. This will result in less economic integration with the EU and also lower productivity and output over the medium term.

“The critical issue is whether the UK can strike deep trade deals with our trading partners elsewhere. This maybe joining the Trans Pacific Partnership or TTIP. At this stage both face significant challenges due to lack of popular support."

TTIP is important to the UK outside EU and could mitigate the effects against leaving the EU, as trading standards will become TTIP standards not EU standards, which Armstrong said “is one way out this conundrum”, but looks unlikely as the it is unpopular due to the amount of encroachment on domestic policy.

Post-Brexit the UK will have multiple sets of negotiations, first with the world trade organization (WTO) where it will have to agree terms with the other 160 member states, as will incidentally the EU, because its terms would also have changed. Second with the EU, third with other member states, as the EU has a 53 trade agreements with other states and lastly TTIP.

UK slowdown

With the UK GDP expected to slow to just 1% in 2017 after a 0.2% fall in the third quarter of 2016 with a risk it will deteriorate further.

Head of macroeconomic modelling and forecasting, Simon Kirby said: “We expect the UK to experience a marked economic slowdown in the second half the year and throughout 2017. There is an even chance of technical recession in the next 18 months, while there is an elevated risk of further deterioration in the near term.”

On Thursday the Bank of England’s monetary policy committee (MPC) is predicted to slash interest rates, for the first time in seven years, to 0.25% from 0.5% in a bid to encourage growth, or add to its quantitative easing programme.

NIESR expects inflation to increase and peak at over 3% by the end of 2017 mainly due to a fall in the value of sterling against the US dollar.

Kirby said: “The MPC should look through this temporary rise in inflation and ease monetary policy substantially in the coming months. Indeed, the slow down we are projecting is conditioned on the assumption that the MPS will cut interest rates to just 10 basis points, starting with a 25 basis point cut at their August meeting.

“The effects on the economy from these interest rate reductions are relatively modest, but our analysis suggests that the reduction in combination with a further round of quantitative easing, of around £200bn, could boost the size of the economy by as much as 1.5% over the next two years.”