The Bank of England said the coronavirus pandemic is likely to cause greater disruption to the economy initially than its most recent stress test envisaged, but the overall economic hit will remain within anticipated boundaries.

The BoE's comments came as it launched an emergency liquidity scheme, its contingent term repo facility, which allows market operators to get hold of central bank cash reserves in return for high quality but less liquid collateral. The BoE said the move is designed to help alleviate frictions in money markets as a result of the economic shock caused by the coronavirus.

Minutes released by the BoE from the most recent meeting of the Financial Policy Committee show that it believes that the pandemic will have less impact on the core banking system than recent stress tests showed the system could withstand.

Those tests showed the banking system would be able to lend to households and businesses even while coping with the shock of a prolonged downturn in the U.K. and other world economies, said the FPC. The moves in the FTSE, S&P 500 and Eurostoxx were all less than half the falls outlined in the stress test scenario, though measures of volatility had reached higher-than-anticipated levels, according to the FPC

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"The disruption from COVID-19 would likely be more severe than the stress test in the first phase but the FPC expected that it would ultimately be less protracted and lead to less output loss overall over the course of two years than the Bank's annual cyclical scenario, which contained a very prolonged fall in output," said the FPC.

It is not the pandemic itself challenging the economy and the banks, but the extreme lockdown policy response, said John Wright, analyst at S&P Global Ratings.

"It'll be very interesting to see whether such intense policy is sustained anywhere for more than one or two months before being softened, partly because the economic damage is so intense. If the working population starts being sent back to work in one or two months the stress will be very different to if the current situation lasts six months or more."

'Big negative shock'

A severe downturn is expected in the U.K. as a result of the virus, with Capital Economics predicting a fall of up to 15% in output in the quarter to June, according to the Guardian, but warning it could be up to 20%. PwC has estimated output could fall 4.7% this year, said the London Evening Standard.

Pandemics have not been included in stress tests in either the U.K. or Europe, even though some relatively recent pandemics have had a considerable impact.

For instance, the SARS outbreak of 2002-2003 resulted in thousands of cases of infections and hundreds of fatalities but caused a fraction of the economic damage compared to COVID-19.

A number of Hong Kong banks staged a stress test based on the effect of a pandemic last October, said Reuters. The BoE's recent stress tests also factored in the possibility of Hong Kong being badly hit with a scenario in which Hong Kong's output falls almost 8%.

The BoE's tests do include a number of features that have resulted from the present pandemic: a highly synchronized and material reduction in global output, a big negative shock to financial market asset prices, a sharp contraction in global trade and an appreciation of the dollar.

Feeling stressed

The BoE has canceled the next round of stress testing due to the coronavirus pandemic, as has the European Central Bank.

All the U.K.'s major banks passed the most recent stress tests from the BoE, which assessed how banks would cope if the world gross domestic product were to fall 2.6%, and if GDP in the U.K. were to fall by 4.7% with unemployment peaking at 9.2%. The test assumed that the BoE's base rate would rise to 4%, while the U.S. dollar would appreciate 10% or more against the Chinese renminbi.

Stress tests should be concerned with prudential and financial parameters which can occur indifferent to the external cause, said Sam Theodore, managing director at Scope Insights.

"Stress tests cannot deal with and reassure for extreme outcomes — like 'this bank's capital and liquidity are well-positioned to withstand this particular extreme situation'," he said.