A no-deal Brexit where the U.K. crashed out of the EU without an agreement could see U.K. GDP fall by as much as 10.5% over a five-year period, the Bank of England said Nov. 28.

Only when the U.K. went back to the gold standard in the 1920s — when output fell 20% — did the country's economy fare worse than the post-Brexit scenario projected by the Bank.

The Bank’s Governor Mark Carney said the study on the effects of a no-deal Brexit — if the U.K. quits the EU without a withdrawal agreement and no transition period — was based on a worst-case scenario where there would be a "sharp reaction" in financial markets. He emphasized that the study was a scenario and not a forecast.

As well as the sharp fall in output, the Bank said unemployment could rise to 7.5%, there could be a slump in commercial property prices of 48%, and house prices could fall by 30% under its disorderly Brexit scenario.

The figures for GDP and house price falls compare with drops of 6.25% and 17% during the financial crisis.

Under the Bank’s study, CPI inflation would rise to 6.5% while the Bank rate could rise sharply to 5.5% in the event of a no-deal Brexit. However, the Bank emphasized that this was not a prediction of interest rate rises, but was based on a mechanical model for interest rates in its scenarios.

Demand shock

The no-deal scenario assumes that U.K. trade would fall sharply as trade barriers were introduced and that the U.K. would revert to World Trade Organization terms, and it also assumes that the U.K. would not be able to strike new trade deals until 2023.

This scenario compared to that based on the deal negotiated by the Prime Minister Theresa May where GDP would still fall over the same period and would be 1.25% to 3.75% lower than it would have been had the economy continued growing as it was in May 2016 — the baseline for the study.

The governor emphasized that a no-deal Brexit would affect the economy differently to the financial crisis and that the bank had made an assumption that the U.K. economy would react sharply as openness was reduced and barriers to trade were created.

"What’s different about this is, it is first and foremost a supply shock — it is a totally different situation than people have been living with in the last 40 years," Carney said.

"This is the opposite of what happened in the financial crisis because principally that was a demand shock ... so monetary policy can be calibrated to adjust demand to bring inflation to target."

The governor said the study was being published at the request of the Treasury Select Committee of MPs, and he denied that doing so compromised the independence of the Bank.

"The Bank is accountable through Parliament, Parliament has demanded this analysis. We have been doing this type of analysis in order to do our jobs, to deliver financial stability, monetary stability. [We look] at what could go wrong, how well can we get prepared so the financial system is part of the solution, not part of the problem," he said.

Stress test

Carney said the bank stress test results which were published Nov. 28 showed that U.K. banks have more than enough capital for a disorderly Brexit — three times as much as before the financial crisis. Major U.K. banks have ample liquidity and hold more than £1 trillion of highly liquid assets and could withstand "many months" without access to wholesale markets.

"We have taken it to the worst-case version of that, [which may be] unlikely, to make sure we’ve done our job. What we’re telling you is, the core of the U.K. financial system is ready for Brexit."

Carney warned that, unlike banks which could survive a disorderly Brexit, businesses were not sufficiently prepared.

"The proportion of business which have activated contingency plans remains a fraction of businesses as a whole," said Carney.

The governor also said the possibility that the U.K. would leave the EU without a deal had increased.

Carney said the Bank’s scenario did not amount to an endorsement of government policy and that the Bank was not providing advice to MPs on how to vote on Dec. 11 when the Prime Minister’s deal is due to be voted on in the House of Commons.

"But we all ultimately serve the same people. The one area [the people] shouldn’t have questions about is the financial system," he said.