- OBR chairman Robert Chote explains what its report means
There are economists who believe that leaving the European Union without a deal on October 31st will immediately revive the UK’s prosperity but they’re in the minority.
The clear majority of economists believe such an abrupt departure would be a significant economic and financial shock.
The Office for Budget Responsibility (OBR) believes that even a rather “benign” Hard Brexit is likely to trigger a recession and blow a hole in the public finances of around £30 billion a year.
The OBR has based its “fiscal stress test” on the International Monetary Fund’s (IMF) “Brexit Scenario A”.
This assumes that a no-deal, no-transition Brexit at the end of October tips the UK into a year-long recession (during which GDP falls by 2.1%); that the pound slumps and trade tariffs are imposed; that inflation rises, squeezing household incomes.
The stress test assumes that jobs are lost and unemployment rises (although by less than in either of the last two recessions) and that welfare spending and the cost of out-of-work benefits rise accordingly.
It assumes that house prices and commercial property prices fall; residential transactions plummet and that business investment nosedives before slowly recovering.
In such circumstances, the OBR believes the Bank of England would respond by cutting interest rates to support demand.
The net effect of all of the above - when compared to the OBR’s forecast in March that assumed a Brexit deal would be done and that departure would be smooth - is a very sharp, painful and sustained fall in tax revenues.
Higher customs duties (as a result tariff charges) and lower debt interest payments (as a result of lower interest rates) are more than offset by a collapse in income tax and national insurance receipts (as a result of job losses) and lower capital tax receipts (as the housing market heads South).
Boris Johnson said recently that the cost of a no-deal departure in October would be “vanishingly inexpensive” if preparations were made.
The OBR’s analysis suggests that Mr Johnson is mistaken. A 30 billion fall in tax revenue would be a very significant hit, one that would make it very much harder to deliver on his pledge to deliver a generous income tax cut.
It’s worth noting that the stress test the OBR has designed is rather modest, a sort of “best, worst-case scenario”. The downturn it models is nowhere near as severe as that the Bank of England considered in its “disruptive and disorderly” scenario last November.
The OBR imagines no disruption at British ports, that the UK temporarily sets tariffs to zero on 87% of EU imports, and that the government spends £10 billion providing support to companies in the private sector who would inevitably struggle.
The chancellor, Philip Hammond, has already suggested the OBR’s assumptions are too rosy to be realistic. Last month he told MPs that a no-deal Brexit would leave the Treasury £90 billion poorer.