The Bank of England (BoE) has warned of the rising risk of a no-deal Brexit in its latest Financial Stability Report.
In recent months, the likelihood of a no-deal Brexit has become an increasing possibility as the Conservative leadership race continues, with both Jeremy Hunt and Boris Johnson recently pledging to leave the EU on 31 October with or without a deal. This prompted sterling to fall to close to its lowest level since April 2017, trading below the $1.25 mark at $1.2455 on 10 July.
The BoE's latest report said that "in a disorderly Brexit, a range of UK asset prices - including the sterling exchange rate, equities, corporate and government debt and bank funding costs - would be expected to adjust sharply, tightening financial conditions for UK households and businesses."
BoE Governor Mark Carney said in the report that if the effects of leaving without a deal result in a tightening of conditions for UK households and businesses, the BoE would be prepared to cut its requirements for banks' ‘rainy-day funds'. This would free up £250bn to lend to the wider economy, he said.
With over £1trn of high-quality liquid assets, the BoE has said major UK banks should be able to meet maturing obligations for many months without accessing foreign exchange or wholesale funding markets.
Businesses and authorities have been planning for a no-deal scenario since November, the report said, with the Financial Policy Committee (FPC) concluding they are now more prepared for the ramifications on the UK economy in the event of a no-deal Brexit.
The report added: "Even if a protectionist-driven global slowdown were to spill over to the UK at the same time as a worst-case disorderly Brexit, the FPC judges that the core UK banking system would be strong enough to absorb, rather than amplify, the resulting economic shocks."
Nonetheless, "material risks of economic disruption remain" beyond Brexit concerns, with the ongoing US-China trade war and the global slowdown in economic growth, the report said.
Quilter Investors portfolio manager Hinesh Patel pointed out that the BoE "has made a point of explaining that this only means there is a satisfactory level of resilience in the system to withstand turbulence, and that this should not be confused with the expectation of a benign response in the markets."
Patel said: "It is also notable that where the November stability report points to broad resilience across the banking sector, it is now speaking only about major banking institutions.
"The tone of voice has also changed somewhat to shift toward talk of a ‘worst-case' disorderly Brexit. That is a small but telling sign that the BoE's Brexit concerns have been growing steadily through the year.
"Although Mark Carney and his colleagues have offered some reassurance that there are adequate defences are in place to protect against major financial instability, investors should still be prepared for the possibility of big swings in the pound and heightened volatility as we move into the autumn and the October deadline for leaving the EU."
He added: "The important thing is to ensure that portfolios are fully diversified in preparation and investors are clear about how they're positioned to manage these scenarios."