April 26, 2019 / 6:12 AM / 2 months ago

Goldman Sachs says dragged-out Brexit is doing deeper damage to UK economy

LONDON (Reuters) - Britain’s protracted divorce from the European Union is hurting the world’s fifth largest economy as dwindling company investment, signs of a looming labour market shock and poor productivity hinder growth, Goldman Sachs said.

FILE PHOTO: Anti-Brexit protesters hold EU flags as they demonstrate outside the Houses of Parliament, as uncertainty over Brexit continues, in London, Britain, April 11, 2019. REUTERS/Gonzalo Fuentes/File Photo

The United Kingdom was due to have left the EU on March 29, though Prime Minister Theresa May has been unable to get her divorce deal approved by parliament. Now the new deadline is Oct. 31, more than three years since the 2016 referendum.

It is now unclear when, how and even if Brexit will happen.

Goldman Sachs said in a note to clients that its base scenario was the divorce deal would be ratified by May 22 but that there was a risk of Britain’s exit being delayed until much closer to the new Oct. 31 deadline.

“The politics of Brexit have become more protracted and, as a result, the side-effects of Brexit on the UK economy have intensified,” Goldman said in a note entitled “Brexit — Withdrawal Symptoms”.

“From both a top-down and a bottom-up perspective, Brexit has taken a toll on the UK economy — even though it has not yet happened,” Goldman said.

It said Britain’s economy has underperformed other advanced economies since mid-2016, losing nearly 2.5 percent of Gross Domestic Product relative to its pre-referendum growth path, in large part due to weaker investment.

Bank of England Governor Mark Carney said in February that Britain had lost around 1.5 percent of GDP compared with the central bank’s expectations before the referendum. Carney said this month that uncertainty facing British businesses has gone “through the roof” due to Brexit.

Capital expenditure by businesses has been particularly subdued, Goldman said, and strong employment data masks a deepening misallocation of resources to labour rather than capital which will ultimately make the economy less efficient.

Since the referendum, firms have hired workers rather than invest in capital, Goldman economists said.

“BREXIT TAKING A TOLL”

Business investment has grown by just 0.3 percent in cumulative terms since June 2016, and 2018 was the first year in at least half a century during which business investment contracted in every quarter without a recession, Goldman said.

An increasingly tight labour market - with unemployment at its lowest since early 1975 and pay growing at its joint fastest pace in over a decade - could also be a sign of strain rather than resilience.

“The balance between weaker demand for workers and a shorter supply of workers bears the hallmarks of a Brexit-induced labour market shock,” Goldman economists said.

Low investment combined with a tight labour market are likely to hurt the economy’s overall efficiency and thus “accentuate the chronic underperformance of UK productivity,” they added.

Britain’s productivity has lagged that of the U.S., Germany, and France, for the past decade.

Business leaders have already triggered contingency plans to cope with additional checks on the post-Brexit UK-EU border they fear will clog ports, silt up the arteries of trade and dislocate supply chains in Europe and beyond.

Opponents fear Brexit will make Britain poorer and divide the West as it grapples with both the unconventional US presidency of Donald Trump and growing assertiveness from Russia and China.

Brexit supporters say there would be short-term disruption but in the long-term the UK would thrive if cut free from what they cast as a doomed experiment in German-dominated unity and excessive debt-funded welfare spending.

“Until the UK’s departure from the EU is resolved, it is difficult to have conviction in a strong rebound in growth,” Goldman said. “In 2020, with Brexit resolved, we do expect a pick-up in activity as uncertainty abates.”

Editing by Thyagaraju Adinarayan, Guy Faulconbridge and Andy Bruce

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