Carney Says BOE Ready for the Worst in Brexit Recession Warning
Mark Carney said the Bank of England is prepared for the worst possible Brexit and that the U.K. faces the steepest economic slump since at least World War II if it crashes out of the European Union without a deal.
The stark warning from the governor sees the economy shrinking by 8 percent within a year and property prices plunging almost a third under a worst-case scenario, with Prime Minister Theresa May failing to get her Brexit plan past lawmakers. For context, the peak-to-trough drop in U.K. GDP in the financial crisis was just over 6 percent.
“Our job is not to hope for the best but to prepare for the worst,” Carney said in a press conference in London. “If there is one thing that you take from an avalanche of papers and numbers and the discussion today, it’s that the core of the U.K. financial system is ready for Brexit, whatever form it takes.”
In a no-deal scenario, questions about the credibility of the U.K. would send sterling into a tailspin, forcing the central bank forced to hike interest rates sharply to combat inflation.
Here are the main points in the “disorderly” Brexit scenario:
- GDP drops 8%
- House prices fall 30%
- Commercial property prices plunge 48%
- Sterling falls 25% to below parity with the dollar
- Unemployment rises to 7.5%
- Inflation accelerates to 6.5%
- BOE benchmark rate rises to 5.5% and averages 4% over 3 years
- Britain goes from net immigration to net outflow, reducing labor supply
The BOE analysis, carried out in response to a request from a committee of lawmakers, is the latest to highlight the dangers from having no new trade arrangements in place by the time Britain leaves the EU on March 29.
While the pound rose about 0.5 percent against the dollar as Carney spoke, that was because Federal Reserve Chairman Jerome Powell simultaneously gave a speech that investors considered dovish. Powell also said the Fed was prepared for a full range of Brexit outcomes.
The BOE’s scenarios are likely to draw the ire of Brexit supporters who said the central bank was too gloomy before the 2016 referendum on Brexit. It warned then that there was a risk of recession in the months following a vote for Leave. The economy kept growing.
Former BOE policy maker Andrew Sentance tweeted that the analysis is “highly speculative and extreme” and will “add to the view that the Bank is getting unnecessarily involved in politics.”
May is pushing her EU Withdrawal Agreement, but it’s not clear she will have the numbers to get it through Parliament in a crunch vote on Dec. 11.
If it’s rejected, the U.K. will be on course to crash out into a legal limbo, with no special rules in place to regulate trade with the bloc. Earlier, the Treasury provided its own longer-term analysis, which also includes a hit to growth and incomes under any Brexit option.
The BOE made clear that a chaotic departure is not its assumption. It provided other options from what it calls a disruptive Brexit to the economic partnership with the EU sought by May.
While a disorderly situation would leave GDP as much as 10.5 percent lower by the end of 2023 relative to remaining in the EU, the loss diminishes to less than 4 percent under an agreement that maintains close ties.
What Our Economists Say:
|“The numbers look very pessimistic, partly because monetary policy is assumed to respond mechanically to a surge in inflation. In reality, would the MPC be so bold as to lift rates in the face of Armageddon? We highly doubt it. Taking a step back, there’s no doubt the BOE is gambling some of its credibility on the analysis but if it helps get Prime Minister Theresa May’s deal over the line, it will be considered worthwhile.”|
-- Dan Hanson, Bloomberg Economics
The immediate hit to the economy from a disruptive Brexit, under which WTO tariffs and other barriers are introduced suddenly, would be about 3 percent, the BOE said. The decline in house prices would be 14 percent.
Carney reiterated that the chance of no deal was small, but it’s not impossible.
“We have always thought it was a possibility, a tail possibility, and maybe the probability has increased with time,” he said. “But even when it was just small probability, our job was to get the system ready to deal with that.”
It’s not clear the gloomy report will change much. While anti-Brexit groups will see it as reinforcing their argument, those in favor of leaving are likely to accuse Carney of reviving what they call “Project Fear.”
The BOE said the country’s top seven banks are all strong enough to continue lending even during a no-deal Brexit, with all of them clearing the latest stress tests, results of which were released separately on Wednesday.
©2018 Bloomberg L.P.