UK credit easing: small arms not "bazooka"

15th June 2012 by Simon Ward

The suggestion here has been that the Bank of England should eschew more QE and instead offer ECB-style medium-term funding to banks at a low interest rate and against wide collateral, in order to reduce borrowing rates and credit rationing. In his Mansion House speech last night, however, the Bank’s Governor, Sir Mervyn King, signalled an extension of QE while announcing two liquidity provision measures that, while helpful, fall short of the ECB’s three-year longer-term refinancing operation (LTRO) initiative.

The most significant of the two measures is the launch of the “extended collateral term repo (ECTR) facility”, under which the Bank will lend at least £5 billion of six-month money each month against a wide range of collateral at a rate to be determined in an auction but subject to a low minimum of 25 basis points (bp) above Bank rate. The Bank previously stated that the ECTR, when activated, would lend for only one month and at a minimum bid rate of 125 bp over Bank rate.

The facility, however, compares unfavourably with the ECB’s three-year LTROs because 1) the amount lent is decided – and will presumably be limited – by the Bank rather than banks, 2) the six-month loan period is relatively short and does not address banks’ medium-term funding difficulties and 3) the lending rate is auction-determined rather than fixed.

The still-formative “funding for lending” initiative, meanwhile, seems designed to inject liquidity only to the extent that banks commit to advancing new loans, suggesting that it will take a long time to grow to the mooted £80 billion. It does not affect the cost of funding existing loan books so promises little if any interest rate relief for current borrowers.

The suspicion, therefore, is that take-up under the two facilities will be much smaller – relative to the size of the economy – than for the ECB’s two three-year LTROs. Such an outcome would suggest that Sir Mervyn, once again, has skillfully resisted political demands for the Bank to deploy the full weight of its balance sheet to improve private-sector credit supply.

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2 thoughts on “UK credit easing: small arms not "bazooka"”

  1. David Lilley says:

    Simon,

    Your excellent blogs deserve comment. Here are my less professional comments:

    1. There seems to have been some friction between the Chancellor and the Govenor of the BoE leading to the former announcing his Treasury proposals for credit easing at the Conservative Party Conference. The details of this easing seem to have morthed into the new proposals by the BoE at the Mansion House. It seems to be a reasonable means of obtaining the Chancellor’s objective of getting money to where it counts whilst at the same time having a professional involved in the form of the BoE. I have no problem with this.

    2. The ECBs LTRO looked great at the time and many considered the EZ crisis to be over as a result but super Mario may now be regretting his E1t intervention.

    3. Mr. Osbourne had an alternative. He could have risked sleepless nights and disbanned the MPC and taken control of both levers; fiscal and monetary. He needs all the tools available to him. He is the Captain of the ship and some of the comments of MPC members have been outlandish.

    4. Mr. Blair and Mr. Brown fight over who’s idea it was to make the BoEs MPC independent and responsible for rate setting. But I can recall three documentaries pressing the New Labour government to do it long before they did it. New Zealand, the Fed and the Bundesbank being sited as examples of the success of an independent Central Bank. There was also the apparently cossie relationship between Ken Clarke and Eddy George that fuelled a political desire to divorce interest rate setting from politics to prevent an interest rate cut prior to an election.

    5. But if you, the Treasury, dictate that base rate should govern the rate of inflation then you still control the base rate. The independence is foggy.

    6. With the introduction of the OBR it is now posible for the Treasury to again take charge of interest rates. Unfortunately Mr. Chote has not been very good at forecasting.

    1. Simon Ward says:

      Thanks David.

      I suspect Mr Draghi does not regret his LTRO initiative but wishes he had the option of full QE, which would have been more effective.

      I’m surprised there hasn’t been more discussion about whether the BoE should retain responsibility for monetary policy given its failures of the past decade and the risk of “mission overload” created by its new supervisory duties.

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