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BOE to Dust Off War Games If No-Deal Brexit Becomes Reality

David Goodman

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Bank of England Governor Mark Carney will soon find himself thrust once more unto the breach if the U.K. crashes out of the European Union without a transition.

The last time he was front and center -- just after the referendum on June 23, 2016 -- he immediately provided reassurance during an unexpected shock that rocked markets and left a power vacuum in Britain’s political class. At least there should still be a government afterward this time, unlike when Prime Minister David Cameron resigned the day following the vote.

A disruptive exit could have a broader economic impact, requiring a faster response that policy makers admit can only go so far. The central bank has made sure banks are ready, but Carney has warned that “financial stability is not the same as market stability.”

The BOE has experience in planning for the worst case scenario. The Scottish referendum in 2014 gave a dry run dealing with a disruptive event, even if Carney never had to deploy the “considerable resources” planned in case of a separatist victory.

“It’s a tried and tested playbook,” said Sanjay Raja, U.K. economist at Deutsche Bank AG in London, which expects the BOE to ease policy immediately at its November meeting. “Cut rates and try to get ahead of it as soon as possible, try and make sure financial and credit conditions remain as accomodative as possible.”

Here’s a look at how the BOE may respond to a no deal Brexit, assuming it takes place at the end of this month.

Before Oct. 31

Should a no-deal exit become official government policy, the BOE will likely immediately kick start contingency plans. The Financial Policy Committee will have a final chance to weigh in this week with the summary of its Oct. 2 meeting on Wednesday.

While the BOE stresses that the financial system is prepared, it also says that it can do little to curtail the inevitable market ructions. Carney says the goal is to prevent problems in the financial plumbing so that the sector doesn’t make things worse.

Before the Brexit vote, the BOE said its plans included “intensive supervision” of banks, additional funding and activation of swap lines with other central banks.

If markets are in freefall, Carney may repeat his 2016 move of reassuring investors that the BOE stands ready to inject liquidity if needed. He may hint at the possibility of more policy action at the Nov. 7 interest-rate decision.

To further ease concerns the BOE could offer lenders extra liquidity provisions. The BOE’s Indexed Long-Term Repo operations are already occurring on a heightened scheduled -- having been held on a weekly basis since around the time of the U.K.’s original March exit date -- and could be further stepped up.

The BOE will also step up market intelligence and meetings with their network of agents, said Tony Yates, a former BOE official.

“Most of things about monitoring and war-gaming, I imagine they are doing that now,” he said. “There will be a permanent frenzy of activity.”

Night of Oct. 31

In 2016, Carney said he napped for about two hours before watching the first results on television and going to the BOE’s Threadneedle Street headquarters at around 3:30 a.m. to oversee coordination with central banks around the globe.

The BOE will be alive to any liquidity crunches. Some volatility is likely, especially if traders are hoping for a last minute reprieve from the EU or British legal system.

Analysts see sterling dropping to $1.11 the day after a no-deal Brexit, from about $1.23 now. But no matter how violently the pound swings, the BOE is unlikely to intervene directly. Carney said in September that there’s almost no chance of that unless there was breakdown in the market.

There’s also real time observations. Chief Economist Andy Haldane said the BOE had developed a “system for monitoring traffic flow around the U.K.’s main ports using geospatial data from Google Maps.”

The Aftermath

The BOE’s first major set piece will be the Nov. 7 Inflation Report. That’s a chance to unveil forecasts under a no deal for the first time, and address any economic turmoil with monetary policy.

While officials have stressed their response won’t be automatic -- partly as it will be hard to ascertain whether the outcome is more damaging to demand or supply -- almost all economists expect a messy divorce to be met with easing. That’s even if inflation surges well above the BOE’s 2% goal.

There could be a rate cut -- possibly to the barely positive level that officials consider to be their zero-lower bound -- more quantitative easing, macroprudential measures, or, more likely, a package of strategies. Bloomberg Economics, which expects a no-deal Brexit in January, expects the BOE to cut the benchmark rate by 70 basis points to 0.05%.

Still, policy makers are also likely to also indicate they can’t solve the problems of a no deal on their own. Michael Saunders told Parliament last year that “if you have queues at Dover, the answer is not lower interest rates.”

--With assistance from Anooja Debnath, Charlotte Ryan and Michael Hunter.

To contact the reporter on this story: David Goodman in London at dgoodman28@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Brian Swint, Lucy Meakin

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