Be prepared to stabilise pound on Brexit, top FX players advise BoE

By Patrick Graham

LONDON (Reuters) - If Britain opts to leave the EU on June 23, the Bank of England should be prepared to intervene to help stabilise sterling for the first time in decades, currency market participants have advised the central bank.

Three industry sources who spoke to Reuters on condition of anonymity, but who have been part of discussions with the Bank about the fallout from the vote, said the BoE is considering last year's Swiss franc shock and its lessons for how to keep sterling markets functioning in the event of a shock from a vote for a Brexit.

The BoE has already announced its willingness to provide banks with extra cashflow if needed around the Brexit vote, and to adjust interest rates if necessary afterwards.

But it has said nothing about intervening directly into foreign exchange markets by buying or selling currency, a step it has not taken since the pound fell out of the European Exchange Rate Mechanism in 1992. Its policy is that markets alone determine the currency's value.

The sources said the BoE gave them no indication about what approach it would take if sterling were to fall precipitously on a vote to leave the 28-country bloc. But they said they told the Bank in clear terms of the lessons learned from Switzerland's franc storm last year.

The sudden lifting of a cap on the Swiss franc rate against the euro in January 2015 saw trading seize up, prices evaporate and the currency's value balloon by 40 percent in minutes, leaving a trail of losses and bankruptcies.

The BoE would not try to influence the ultimate market level of sterling once the dust settles after a vote for Brexit, but could seek to prevent the sort of damaging gyrations seen in the half hour after the removal of the floor on the franc, the sources said.

"The Bank is considering what it should be doing on the day and intervention is naturally one of the options," said a senior official at one of the industry's biggest brokerages, asking not to be named.

"Of course they will not say publicly what their conclusion is, but I am sure they are considering how they would intervene on the day if need be."

The Bank of England declined to comment when asked about any preparations it might be making to stabilise sterling.

The BoE has previously announced it will hold extra sterling liquidity auctions around the time of the June 23 vote. It has also said it might need to cut interest rates to offset the shock to the economy from an "Out" vote, or do the opposite and raise them if a plunge in sterling creates inflation pressures.

DISORDER

BoE Governor Mark Carney said on Sunday that attempts to defend sterling during the ERM crisis were "a debacle".

Rather, any moves by the Bank would be about financial and market stability, preventing swings in the pound due purely to momentary uncertainty about its real value or a lack of buyers.

"Disorderly markets" such as in last year's Swiss shock are the exception to the agreed consensus among the G7 countries that major central banks should avoid meddling in the free markets in their currencies.

"The overwhelming consensus on (last year's franc event) is that it shows you should intervene on the way down to provide the market with rates at which people can get out (of losing trading positions) on the way to the new equilibrium," said a second industry source with close ties to the BoE.

"That is well within the BoE's remit to prevent disorderly markets."

He said that it was "unimaginable" that Carney and the Bank would have warned in last week's Inflation Report that the Brexit vote was the biggest risk to the Bank's forecasts without considering all eventualities on sterling.

Any decision to move sterling for economic policy purposes would have to be backed by the UK Treasury and, given its relatively limited currency reserves, the Bank would likely also need the backing of other central banks.

A third source pointed to a comment by the International Monetary Fund last week that the BoE might need to activate existing swap lines with the U.S. Federal Reserve and other central banks as evidence that preparations have been made.

"Carney could not have said what he said last week without having put in place a plan," said the second source. "Intervention would clearly have to be a part of that."

LET IT BE

Odds for now at least are that it will all be for nothing. Several polls this week have shown Britain is leaning towards remaining in the 28-country bloc. Betting markets price an 80 percent chance voters will opt for the status quo.

As well as the additional repo operations around the vote, in the era of quantitative easing and high capital buffers, banks are rich with cash anyway.

And whereas the timing of the Swiss central bank action last year came as a complete shock to markets, the Brexit vote is a known risk for which markets have been preparing.

"It is not clear to me how markets are going to go, 'oh my God, we haven't thought about this' (on the day)," said Neil Record, a former BoE economist and founder of one of the market's big institutional players, Record Currency Management.

"The Bank should do a Mrs Thatcher, make sure the commercial banks are fully liquid and let the market do the rest."

(Writing by Patrick Graham; editing by Peter Graff)