BoE offers Brexit warnings, after standing pat on rates

The Bank of England warned Thursday that Britain could suffer an economic shock if it crashes out of the European Union without a deal, saying it could cause gridlock at ports and an inflation-rearing fall in the pound that could require an increase to interest rates.

After the bank kept its main rate at 0.75%, as expected, Governor Mark Carney said the supply capacity of the British economy—basically what the country can produce—could “fall sharply” in the event of a disorderly Brexit.

“An abrupt and disorderly withdrawal could result in delays at borders, disruptions to supply chains, and more rapid and costly shifts in patterns of production, severely impairing the productive capacity of some U.K. businesses,” he said.

Even in that scenario, Carney said he could foresee the bank being forced to raise interest rates. Whether it does could depend on how the pound reacts to the prospect—after Britain voted to leave the EU in June 2016, the currency fell 15% against major currencies and that stoked inflation by making imports more expensive.

The bank, which is tasked with keeping inflation stable, is predicting another fall in the pound if Britain leaves the EU without a deal and no transition to smoothen out the exit.

“There are scenarios where policy would have to be tightened,” Carney told a news conference, while adding that a no-deal Brexit is “not the most likely scenario.”

Many economists doubt that the central bank’s initial response to a disorderly Brexit would be to increase rates. After the 2016 referendum, when the pound had fallen, the bank cut interest rates.

The Bank of England, which has raised its key rate twice over the past year, is more likely to slash its benchmark rate to zero, economists say. It could also extend its stimulus program by potentially buying corporate bonds.

Carney’s comments come as Prime Minister Theresa May struggles to keep her divided Conservative Party in check during what looks like the final stages of the Brexit discussions.

The talks are hung up in particular on the question of how to avoid reinstating a hard border between EU member Ireland and Northern Ireland, which is part of the United Kingdom.

A summit of EU leaders in October was supposed to be the moment by which to reach a Brexit deal, to give parliaments time to pass it into law ahead of the March departure. Now, officials are talking about a summit in December as the last chance for a deal. By then, many Britain-based firms may have already activated contingency plans that could include transferring business to the continent and cutting jobs.

May’s proposal for a Brexit deal is to essentially keep Britain in the European single market for goods, which would avoid tariffs and help keep supply chains operating with delays. Carney noted that aspects of May’s plan are unclear, particularly regarding the financial services industry.

One clear impact of the Brexit uncertainty has been a decline in business investment. In a survey, the Bank of England found that more than 50% of firms identified Brexit as being one of the top three sources of uncertainty in September and October, up around 10 percentage points from August.

The bank said there has been little evidence of significant precautionary stock-building ahead of Brexit, though it said it’s possible that could occur over the rest of this year and early next if concerns about Brexit persist. If the Brexit transition goes smoothly, the central bank is predicting a pickup in business investment next year.

That would help growth rise to around 1.75% a year on average over the coming three years. Under this scenario, interest rates would rise by a quarter percentage point per year over the period.

But, echoing comments by the Treasury chief this week, Carney said the bank would have to revisit its forecasts in the event of a no-deal Brexit.

“The economic outlook depends significantly on the nature of EU withdrawal, in particular the form of new trading arrangements between the EU and U.K. and whether the transition to them is abrupt or smooth and how households, businesses and financial markets respond,” he said.