The chancellor said ministers would have no choice but to “refocus government priorities”, to head off the economic damage from a no-deal Brexit.
“In no deal circumstances, we would have to refocus government priorities so that government was concentrated on the circumstances that we found ourselves in,” he said.
Mr Hammond has previously warned of a near-8 per cent hit to GDP from a no-deal Brexit, which would blow an £80bn hole in the public finances.
The concession opens up the prospect of austerity continuing into the next decade, despite growing pressure – including from some Tory MPs – to turn the spending taps back on.
It also threatens to reignite the Conservative party’s civil war over Brexit, after Mr Hammond was accused of a fresh “Project Fear” when he last warned against a no-deal departure.
Mr Hammond’s comments came after the government was embarrassed by the latest example of someone – thought to be John Glen, a Treasury minister – being photographed carrying an internal document.
As well as revealing the codename “Operation Yellowhammer”, it appeared to acknowledge questions about “rail access to the EU” after a no-deal Brexit.
The paper said the Treasury would need to “maintain confidence in the event of contingency plans being triggered – particularly important for financial services”.
And it exposed that planning is being overseen by the Civil Contingencies Secretariat, which is usually responsible for coping with emergencies such as floods and disease outbreaks.
Ben Bradshaw, a Labour supporter of the People’s Vote campaign, seized on the controversy, saying: “We now know the government is preparing for Brexit in the same way they’d approach catastrophes like flooding, a disease outbreak or a terrorist attack. This is not what anyone voted for in 2016.”
Questioned by the BBC on a visit to Glasgow, Mr Hammond denied that cuts would be necessary to prepare for the risk of crashing out next year, after an extra £1.5bn was set aside for departments.
But he pointed, instead, to what happens after a no-deal departure, saying: “What we’re beginning to discuss is now part of long term contingency planning.”
The chancellor added: “Let me reiterate again that is not the outcome we are expecting and it’s not the outcome we’re seeking.”
The prime minister’s spokesman played down oversight by the Civil Contingencies Secretariat, insisting it was “routine” for any significant event – including major sporting events in the UK.
And he said the codename Operation Yellowhammer had been “generated at random” – after it was pointed out that the bird’s song is said to have a rhythm like “a little bit of bread and no cheese”.
The spokesman declined to be drawn on the questions surrounding “rail access to the EU”, ahead of the publication of further no-deal “technical notices” – as early as next week.
Asked if a no-deal Brexit would have “consequences” for cross-Channel rail, he said: “We are preparing for all potential scenarios across all sectors.”
And asked if the Channel Tunnel rail link would definitely remain open, he replied: “I have no reason to think otherwise, whatsoever.”
The Independent has launched its #FinalSay campaign to demand that voters are given a voice on the final Brexit deal.