This week I have been examining aspects of the UK economy and the central theme of this is that our economy is going to continue to struggle if wage growth remains so weak. This is because it has fallen well below the level of annual inflation meaning that in real (inflation adjusted) terms we overall have less income which has obvious implications for likely spending levels. Thus domestic demand will be weakened by this and if we add in that individuals are also deleveraging mostly by repaying debt the outlook for domestic demand does not look bright.
The official policy response has been to reduce official interest-rates to 0.5% and then to undertake a range of monetary stimulus programmes such as Quantitative Easing and the more recent Funding for Lending Scheme. These are officially described as operations designed to reduce longer-term interest rates and encourage bank lending to stimulate the economy. I however have regularly pointed out that these stimulus plans have as their clearest effect operated as a boost for bank profitability. However the official view has been that such policies will boost the economy via stimulating credit in spite of “surprises” and unintended consequences such as their effect on inflation contributing to a fall in the level of real wages of around 8% so far.
How is the policy doing?
The Bank of England has issued its latest report on Trends in Lending in the UK this morning and its opening salvo must have been very uncomfortable for itself.
The annual rate of growth in the stock of lending to UK businesses was negative in the three months to February.
We are getting rather used to unfulfilled promises in this area are we not? In fact it gets worse.
The stock of lending to both small and medium-sized enterprises and large businesses also contracted over this period.
Indeed the most hopeful part was this bit.
The annual rate of growth in the stock of secured lending to individuals was broadly unchanged.
I read the last part with a wry smile as I have been arguing that the mortgage situation was not living up to the official hype for a while but as ever there were plenty happy to back the official line and tell me that I was wrong. Indeed prospects look none too good either.
Mortgage approvals by all UK-resident mortgage lenders for house purchase fell slightly in the three months to February
Remember also that we were promised that all this easing would lead to lower borrowing costs for industry and individuals?
The Bank’s measure of the effective interest rate on new borrowing for businesses was broadly unchanged in the three months to February.
That phrase “broadly unchanged” seems to be popping up a bit does it not? As I wonder if it should find its way into my financial lexicon for these times. Also those concerned about the small and medium sized business sector (SME) will be alarmed by this bit.
In the survey, net balances of small and medium-sized firms reported some increase in costs over the same period,
Yet again we find ourselves observing that up is the new down!
Actually the chart showing borrowing costs for the smallest companies shows a sharp rise to nearly 5% as we moved into 2013.
Remember the promises of the Funding for Lending Scheme?
What does it actually do?
The FLS offers banks a cheap source of funding
What were we told would happen as a consequence?
Together, lower overall bank funding costs should allow banks to increase the availability of credit by cutting loan rates or easing other, non-price terms. The resultant increase in lending should be associated with higher consumption and investment spending.
The emphasis is mine to illustrate the gap between what we were promised and reality. Although “should allow” gave something of a get out clause the phrase “resultant increase in lending” looks hollow now.
Where did it all go wrong?
We see that one more time cash goes into our banking sector and in the manner of the South Park episode “It’s Gone” it then fails to emerge into the outside economy. Let us take a look at the original promise again.
the FLS boosts banks’ incentives to lend by making both the amount and price of funding available to banks conditional on their lending to the UK real economy
Now if we move from fantasy to reality we can observe that the Lloyds Banking Group has drawn some £3 billion of cheap FLS funding in return for reducing its lending by some £5.6 billion! I think everyone can spot the flaw. It gets worse as overall FLS had provided some £13.8 billion of cheap lending in the second half of 2012 in return for lending falling by £1.5 billion and today’s report suggests that 2013 was no better and may in fact be even worse.
We find ourselves in a familiar situation where a monetary stimulus programme in fact appears to have turned into a bank profitability stimulus programme. The worst part of this is that we have replicated one of the failures of the Japanese experience. You see the Bank of Japan tried this sort of policy and what happened was banks begged large relatively low risk companies to borrow and did nothing for smaller business who were supposed to be the objective. Spot the difference here from the Bank of England’s Agents Report.
The survey showed that for large firms,(1)there had been an improvement in credit availability compared with a year earlier…..while among the small firms surveyed, slight net balances reported a deterioration in the availability and cost of borrowing
Remember large firms have cash balances overall so the point of improving credit to them is what exactly?
If we move to the mortgage sector there have been reductions in mortgage rates. But this too seems to have had a disappointing effect on volumes and an old problem seems to be back.
For Buy To Let lending, lenders in the survey expected a significant increase in demand and lower spreads in 2013 Q2.Respondents to the Bank’s 2013 Q1 Credit Conditions Survey reported a significant reduction in BTL secured lending spreads.
A fundamental problem here is the issue that you can simply increase the supply of credit and demand will appear for it. That at best is questionable right now as we have changed over the credit crunch period and if we move to the small business sector I would like to know all the terms of the offers of bank lending they have received as I suspect that some will be onerous. Splitting supply and demand is much more difficult in practice than it is in a textbook.
In other news the incoming Governor of the Bank of England Mark Carney has stated that “forward guidance” on interest-rates will be a tool of his Governorship. As the Bank of England’s record on economic forcasting has veered between poor and appalling what could go wrong?
The International Monetary Fund
The last couple of days has seen the International Monetary Fund hold its spring conference. You might think that considering the failures of its interventions in the Euro area periphery some of which are utter failures it might be displaying a large dose of humility. Even worse its Managing Director Christine Lagarde has been offering all sorts of advice which the media are reporting without pointing out that on her track record the correct path would be to do the opposite of what she says!