The Treasury would be forced to open the spending taps to shore up the economy in the case of a no-deal Brexit which causes sharply rising inflation, a collapse in the pound and higher interest rates, Chancellor Philip Hammond has suggested.
Mr Hammond told MPs that the expected spike in inflation would make it “very difficult” for the Bank of England to reduce interest rates as it did following the 2016 referendum, leaving it to fiscal policy – taxation and spending – to “carry much of the short-term burden”.
Giving evidence to the Commons Treasury Committee, the Chancellor described no-deal as a “terrible” outcome, and said that MPs contemplating voting down Theresa May’s deal on December 11 should understand the full implications of what might happen.
He pointed to Whitehall analysis suggesting UK GDP could take a 9.3% hit over 15 years in “a needless loss of consumption in the economy”.
Mr Hammond also warned that a Brexit outcome which left the UK trading with the EU on World Trade Organisation terms would require “very significant” infrastructure work in ports such as Dover which would take a number of years to complete.
The Chancellor, who backed Remain in the referendum, said that any Brexit outcome would leave the UK worse off than staying in the EU.
But he said the likely economic hit was outweighed by the need to avoid the damage to society from ignoring the referendum result.
“We need a way forward which heals our country,” he told the committee.
“We are a deeply fractured country, with opinion heavily polarised and trust in the political system correspondingly damaged. I would suggest… that divided countries are not successful countries.”
Mr Hammond said the UK’s future success “depends on us executing the instructions of the British people in the referendum, leaving the EU, but doing so in a way that minimises the impact on our economy and maximises the opportunity that we have in the future”.
He warned: “Any solution which left the country divided, left a large segment of the population feeling betrayed … would have a negative political and societal impact that would far outweigh the very small economic impact that the white paper scenario is showing.”
The shock of a no-deal Brexit would make it difficult for the Bank of England to provide monetary policy support to the economy, in the form of interest rate cuts or quantitative easing, said the Chancellor.
“We would expect to see inflation rise sharply in response to a reduction in the sterling exchange rate, and the Bank’s normal monetary policy response to that would be to have to tighten monetary policy, not loosen it,” he explained.
“So I suspect that in that scenario the Bank of England would be looking firmly at the Treasury to respond through a fiscal policy response.”
He compared the longer-term economic adjustment that would follow a no-deal outcome to the move away from heavy industry during the Thatcher years.
“Over the medium to longer term of course, the UK economy will have to adjust to the new reality,” he told MPs.
Industries dependent on trade with the EU would either have to “significantly lower their costs” to offset the burden of additional frictions, look for new markets or shift capital and labour into other areas of activity, he said.
A “prolonged period of adjustment” would be similar to the 1980s, when “over a period of time – perhaps nearly a decade – our economy made a significant adjustment away from certain patterns of industrial and commercial activity to a different set of commercial and industrial activities”.
But he said that the full scale of work required to prepare Dover for the border checks required under a WTO scenario could not be completed by Brexit day on March 29.
“The planning system would struggle to approve such significant infrastructure changes in two years, never mind getting them built,” he told Dover MP Charlie Elphicke.
“I think it would take quite a lot longer to deliver the kind of major infrastructure change that might be needed.”
In a message to Conservative MPs threatening to vote against Mrs May’s deal because of its backstop arrangement for the Irish border, he insisted that the time limit they want “isn’t on offer”.
He told the committee: “If Parliament doesn’t agree to go forward with a negotiated proposal, clearly we are in uncharted territory.
“But the important thing is that when Parliament makes that decision, all MPs are fully aware of the implications of adopting any of the other scenarios as a way forward. That will have consequences both in the short term and long term for the economy and it is important people understand that.”