No-deal Brexit would be worse than 2008 crash - BoE

The Bank of England warned that if Britain leaves the European Union without a deal it would result in a recession worse than the 2008 financial crisis, though in this case the UK banking system should be able to cope.

In the worst-case scenario of a no-deal Brexit, the central bank warned that it would result in gross domestic product dropping 8% from the level in the first quarter of 2019, with house prices tumbling by almost a third and commercial property almost half, as unemployment climbs from around the current 4% to 7.5%.

Providing its analysis of various Brexit scenarios after a request by Westminster, the BoE on Wednesday said the fall-out from a “disorderly” Brexit scenario would see the pound could crash to below parity with the dollar and inflation surging to 6.5%, which would require the Bank to raise interest rates as high as 5.5%, and averaging of 4% over three years.

In the recent financial crisis, the GDP crashed 6.3% and unemployment topped off above 8%.

The Bank pointed out that these were scenarios rather than forecasts. “These scenarios illustrate what could happen, not necessarily what is most likely to happen under a range of assumptions,” it said.

If a scenario where the UK were to maintain a "close" economic relationship with the EU, including comprehensive arrangements for free trade in goods and services, this would boost GDP growth by 1.75% over the next five years, the Bank said.

An earlier report, released separately by the government after collating calculations from economists from across government departments, suggested the economy will shrink over the 15 years following the UK’s departure from the European Union, regardless of whether a deal is agreed or not. Under a scenario that most closely resembles Theresa May's currently agreed deal, the report suggested the economy will shrink by 3.9% over 15 years, or in the event of a no-deal exit would be 10.7-8% worse off.

A separate report by the BoE, following its latest round of so-called 'stress tests', the Bank said the country's lenders are ready to face even the worst possible scenarios, even under a scenario of "deep" and simultaneous economic recessions in Britain and overseas of a worse level than the 2008 financial crisis.

“UK banks have levels of capital and liquidity to withstand every severe economic shock that could be associated with a disorderly Brexit,” the report said, noting that capital ratios are now three-and-a-half times higher than before the financial crisis.

The assumptions, such as a rise in interest rates to 5.5%, "seem pretty implausible", said economist Ruth Gregory at Capital Economics. "However, this was always likely to be a worst case scenario, allowing the Financial Policy Committee to assess the implications for financial stability."

With GDP estimated to be 1.75% higher by end-2023 in a scenario of a “close” relationship, Gregory said this suggested that the Bank will revise up its forecasts closer if a Brexit deal is secured.

While the report could be derided as another "Project Fear" exercise, Lukman Otunuga, research analyst at FXTM, the support for May's deal "may offer Theresa May some ammunition when she sells her Brexit deal to parliament.”