Bank warns of immediate economic crash, GDP to fall by 8%, unemployment to rise to 7.5%

Britain crashing out of the European Union without a deal could trigger a deep and damaging recession with worse consequences for the UK economy than the 2008 financial crisis, the Bank of England has warned.

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Raising the stakes as Theresa May battles to win support in parliament for her Brexit deal, the central bank said that failure to reach a deal with Brussels – with no transition period to a new trading relationship – could spark an immediate economic crash.

GDP could fall by as much as 8% next year, exceeding the depth of the recession that followed the financial crisis in one of the worst-ever peacetime capitulations for the economy. However, the gloomy figures were criticised by respected economists Paul Krugman, a former winner of the Nobel prize in economics, and Andrew Sentance, a former member of the bank’s interest rate-setting committee, who said they were too severe.

According to the Bank’s analysis, house prices could fall by 30% and the unemployment rate could increase from its current level of 4.1% to about 7.5%, while interest rates could be forced to rise as inflation increased to 6.5%.

In sharp contrast, the Bank said May’s Brexit deal had the potential to encourage a bounce for economic growth over the next five years, relative to its current forecast, although only if Britain maintains the closest possible trading ties with the EU.

In the event ministers agree a close economic partnership with Brussels of the kind advocated by the prime minister, the best-case scenario could see GDP rise by as much as 1.75% over the next five years.

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It said a “less close” economic partnership, with customs checks on UK-EU trade but without a hard border in Northern Ireland, could cause the economy to shrink by about 0.75% over the same period.

The Bank warned that both scenarios were not definite forecasts and relied on it making assumptions on Brexit decisions that had not yet been made or agreed with the EU.

It also did not model the potential outcome of Britain falling back on to the Northern Ireland “backstop” arrangement after the transition period, even though that was a possibility.

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All of the outcomes are still worse than if Britain had voted to stay in the EU two years ago, with the Bank estimating that GDP starts all of its scenarios about 1% lower than it would had there been a vote for remain.

In making its assessment, the Bank said the consequences of a no-deal scenario would be particularly severe because the majority of UK companies have made no preparations for Britain leaving the EU without a transition period or plan for a new economic partnership.

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While the worst-case scenario is extreme, it is likely to raise eyebrows because it includes the Bank raising interest rates as high as 5.5% – something which many economists doubt would happen because it would amplify the damaging effects of a no-deal Brexit.

Andrew Sentance, a former member of the Bank’s rate-setting monetary policy committee, was scathing about the assessment. In a tweet he warned that the analysis was “highly speculative” and would add to accusations that the Bank is becoming politicised.

Andrew Sentance (@asentance) The @bankofengland #Brexir analysis is highly speculative and extreme. It will add to the view that the Bank is getting unnecessarily involved in politics and that will further undermine perceptions of its independence and credibility.

Paul Krugman, whose work on trade won the Nobel prize in economics in 2008, said the GDP decline scenarios looked “extremely high”.

Paul Krugman (@paulkrugman) And I won't make a full judgement until I see the details. But their bad-case losses from a no-deal Brexit look extremely high. I mean, 8 percent of GDP was the kind of estimate we used to make for countries with 150 percent effective rates of protection. 2/

However, the Bank has said it might be forced to raise rates to maintain its remit set by parliament to keep inflation low.

It said a no-deal Brexit would cause a sharp supply shock to the British economy that would lead to demand for goods and services exceeding supply, pushing up the rate of inflation, which it would need to tackle by raising rates.