Bank of England governor Mark Carney has warned interest rates could rise in the event of a no-deal Brexit if a cliff-edge withdrawal sends the pound into free fall.
Mr Carney said there are scenarios where policy “might need to be tightened in the event of a no deal, no transition Brexit”, should a plunge in the value of the pound cause inflation to surge and impact UK production.
He stressed a no-deal Brexit was “not the most likely scenario”, but said the Bank had to be prepared for the worst case and this could mean rates moving in “either direction”.
The Bank’s boss also cautioned that monetary policy might not be able to help soften the economic blow of a no-deal disorderly Brexit.
“There is little that monetary policy can do to offset large, negative supply shocks, which occur relatively rarely in advanced economies,” he said.
His comments came as the Bank’s nine-strong Monetary Policy Committee (MPC) voted unanimously to leave interest rates unchanged at 0.75% as it awaits the outcome of Brexit talks.
In its quarterly inflation report published alongside the rates decision, the Bank sketched out how it could respond to various Brexit scenarios.
“The monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction,” it said.
In a stark warning, the Bank cautioned over queues at ports and a significant hit to UK manufacturers if the UK crashes out of the EU without a deal.
Mr Carney said: “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 UK businesses.”
He added that “whatever happens, monetary policy will act to ensure price stability and, subject to that, provide support for the economy during the transition”.
The Bank’s report revealed the toll Brexit is taking on the country, with business investment now predicted to screech to a complete halt overall this year as uncertainty wreaks havoc on company spending decisions.
Consumer spending has been helping prop up the economy, with a summer heatwave shopping spree set to see growth accelerate to 0.6% in the third quarter, up from 0.4% in the previous three months, according to the Bank.
But this is likely to have been only a temporary boost, and the Bank expects growth to pare back to 0.3% in the fourth quarter before steadying at 0.4% thereafter.
This saw the Bank trim its forecast for growth overall in 2018, to 1.3% from 1.4% predicted in August, while it also nudged its 2019 outlook down to 1.7% from 1.8%.
Its forecasts are based on a “smooth” exit from the EU, with financial markets pencilling in around one rate rise a year for the next three years.
However, the Bank admits the economic outlook will “depend significantly on the nature of EU withdrawal”.
It offered a glimmer of hope for worried businesses, as it said policymakers saw greater clarity on Brexit emerging “in the relatively near term”.
It comes as reports on Thursday suggest that Prime Minister Theresa May has made significant in-roads into securing an agreement for financial services firms to operate across the EU after March 29.
The Bank’s latest report highlights the balancing act policymakers would face as it seeks to support growth while preventing runaway inflation should the pound crash.
While it would normally raise rates to rein in surging inflation, the Bank can look through this on a temporary basis to bolster growth, as it did in the aftermath of the 2016 EU referendum.
It could take this approach again if needed, in “exceptional circumstances”, the Bank said, although inflation is higher now than it was in 2016 – currently at 2.4%.
ING economist James Smith said a rate hike was unlikely in a no-deal scenario.
“Given the wide-scale disruption that would likely occur, we suspect policymakers would ‘look through’ any spike in prices caused by a weaker pound, and cut interest rates/increase quantitative easing fairly swiftly,” he said.