Where previously, the ratings agency had expected UK GDP to grow by 1.8% this year and 2.1% in 2017, it now believes growth will average 1.5% and 1.2% in 2016 and 2017 respectively.
While acknowledging that both short and long-term forecasts are subject to unusually large levels of uncertainty at present, it said: “We now expect investment spending to weaken considerably over the rest of this year and next… Our baseline assumes that some fiscal loosening and monetary policy accommodation will support the economy, limiting the deceleration of growth.”
Moody’s expects the Bank of England to look past any short term rise in inflation above target as a result of pass-through from the sharp decline in sterling and keep monetary policy close to zero.
However, it added that it is easy to conceive of a scenario where annual GDP growth averages as little as 0% – 0.5% in 2017 because of a larger-than-currently-expected hit to consumption, especially it said if “hiring slowed down and some households reevaluated the decisions to buy big ticket items such as entertainment, travel, car and home purchases and remodelling”.
“In addition, substantial downside risks to aggregate demand could materialize if economic weakness led to a material correction in asset prices or a house price downturn,” it said.
Looking ahead through to the new deal, Moody’s base case is for a trade arrangement that is less efficient that the current free market arrangement, but more efficient than current World Trade Organisation norms, which should, it said result in real GDP growth converging around 1.8% over the long run.
Should the EU and UK be unable to come to any trade agreement and the relationship is governed by WTO rules (Moody’s worst-case scenario) then it said, long term growth could fall by half to around 1%.
There is the added danger, it said that trade negotiations could last as long as 10 years and, if so the resultant reduced trade and foreign investment could hamper productivity gains and long run growth potential.
The firm said, however, that there are also significant downside risks to its baseline forecasts: the ongoing political crisis which could see the support for the leave vote being challenged; Scotland and Northern Ireland’s future within the UK remains a question mark because of their overwhelming support for the ‘remain’ campaign; and, finally the fact that trade negotiations are rarely smooth.
“The EU may not entertain significant trade concessions without free movement of people and substantial contributions to the EU budget. Potential restrictions on trade in financial services is a serious downside risk to the UK as the financial services industry represents 8% of the economy in gross value added terms. A decline in this sector will undoubtedly spread across the economy,” Moody’s said.
