UK recession in 2017, forecasts Goldman Sachs

The UK is likely to enter a "mild recession" by early 2017, following its vote leave the European Union (EU), Goldman Sachs economists wrote in a report.

The bank's economists also downgraded its global growth forecast by 0.1 percentage point to 3.1 percent in 2016.

U.K. gross domestic product (GDP) would take a 2.75 percentage-point hit in the next 18 months from the cumulative effects of "increased uncertainty and deteriorating terms of trade," Goldman Sachs' Jan Hatzius, Jari Stehn and Karen Reichgott wrote.

Goldman's forecast for GDP growth in the U.K. this year was 1.5 percent, a 0.5 percentage-point drop from its previous forecast, while the bank's prediction for U.K. growth next year is 0.2 percent, a 1.8 percent decline from its previous forecast.

The economists listed three "economic transmission mechanisms" from the shock Brexit vote.

"First, the UK terms of trade are likely to deteriorate, especially if it becomes harder to export high-value added services (including financial services) to the European Union," the note said.

"Second, the uncertainty about the long term is likely to weigh on UK growth in the short term as firms hold off on investment...Third, outside the UK the main transmission channels are weaker UK demand for imports and—much more importantly—a tightening of financial conditions via a stronger exchange rate and lower risk asset prices."

The euro zone's GDP would fall by 0.5 percentage point to 1.25 percent over the next two years, the economists said. They also cut their second-half 2016 forecast for U.S. growth to 2 percent from 2.25 percent.

"Further downward adjustments could become necessary if global financial markets deteriorate beyond the initial reaction, or if we see greater than expected political and economic contagion into other European countries," they wrote.

Commenting on central banks, the economists said in reference to the U.S. Federal Reserve that the Brexit shock "has effectively taken a July hike off the table."

The Bank of England was likely to cut interest rates by 25 basis points to 0.25 percent and introduce renewed credit easing, while the Bank of Japan may cut at its July policy meeting, they added. 

A basis point is 1/100th of a percentage point.

Source: CNBC