The Bank of England’s response to Britain leaving the European Union without a deal would probably be to put interest rates up, according to its governor Mark Carney.
He said the market should divide the potential outcomes of a no-deal Brexit into two groups. He said there could be a no-deal scenario which is orderly, whereby the UK reverts to trading with the rest of the world under World Trade Organisation rules after a transition period, and a disorderly Brexit without a transition period.
Appearing before the Treasury select committee this afternoon, Mr Carney said there would be an immediate jump in inflation in the event no deal was reached because sterling would fall in value, similar to what happened after the referendum in 2016.
But while the inflation jump in 2016 proved to be temporary, investors could not be sure the rise in inflation which happens after a no-deal Brexit would be.
Mr Carney said this was because the supply of goods and services to the economy would become more expensive due to tariffs.
Henry Dixon, who runs the £1.1bn GLG Undervalued Assets fund, has said since sterling would probably fall by more than the size of any tariffs, Britain's exports would probably become cheaper, boosting the economy.
But Mr Carney said the impact of inflation caused by a fall in sterling would be felt in the economy for several years, and it would take time to adjust to whatever the new regime was.
He said this would leave the bank with a choice between ignoring the fact inflation was higher than the 2 per cent target to stimulate economic growth, or put rates up.
Mr Carney said that in 2016 when inflation rose above target because of the currency fall, the bank ignored this because it felt it would be temporary but he said if it were to happen in a worst case Brexit scenario, the central bank would likely take the view this would be longer term and have to put rates up.
He added his base case remained that an agreement wouldbe reached and he said he expects wage growth to pick up because the number of people who employed but switching jobs was rising, since people typically switch jobs to get a higher salary.
Also during the hearing Mr Carney said he was in discussions with the government about extending his term as Bank of England governor for another year. He said he expected an announcement "in due course".
Nicky Morgan, chair of the Treasury Committee, said following the meeting: "Mark Carney indicated that he is willing to stay as governor of the Bank of England beyond June 2019 if it would assist the government.
"Stability is vital during this important period. The sooner the government provides clarity, the better. Any extension to Dr Carney’s term should not be used to delay succession planning."
Anthony Gillham, head of investment at Quilter Investors, said appointing Mr Carney as "temporary caretaker" made sense.