Lending facilities offering vital support - Capital Economics
Global Economics

Lending facilities offering vital support

Global Central Bank Watch
Written by Jennifer McKeown
This month has seen a further shift among the world’s major central banks from essential liquidity provision to recovery support, with a focus on uptake of the various lending programmes. The results so far have been somewhat mixed. It seems likely that uptake of the various schemes will rise in the months ahead as the newer ones become better established and as government schemes are gradually phased out.
  • Uptake of central bank lending facilities has been mixed
  • But lending is reaching firms, either through governments or central banks…
  • … and central bank backstops are offering important reassurance to investors

This month has seen a further shift among the world’s major central banks from essential liquidity provision to recovery support, with a focus on uptake of the various lending programmes. (See our previous Global Central Bank Watch for details of the various facilities and their aims.)

The results so far have been somewhat mixed. Gross uptake at the ECB’s June Targeted Long-Term Refinancing Operation (TLTRO-III) was €1.3trn, suggesting that the increase in generosity and eligibility for the loans announced back in March has served to incentivise borrowing among commercial banks. Even once the repayment of loans from previous longer-term refinancing operations is considered, the net uptake of €548bn was still very strong and will take total borrowing to a record high of €1,584bn, or around 12% of GDP. (See Chart 1.)

Chart 1: Total LTRO Borrowing (€bn)

Sources: Refinitiv, Bloomberg, Capital Economics

On the face of it at least, the Fed’s new policies have been somewhat disappointing. So far, it has made only $143bn of loans under its new 13(3) facilities, which is just 6% of the total funding available or about 0.7% of GDP. (See Chart 2). This partly reflects the fact that the Term ABS Loan Facility or TALF which will make loans in exchange for a variety of consumer and business debt posted as collateral – and the Main Street Lending Program – which will extend loans more directly to small – and medium-sized businesses – only launched in mid-June. And the Primary Market Corporate Credit Facility is yet to be rolled out.

Chart 2: Fed’s 13(3) Lending Facilities ($bn)

Sources: Refinitiv, Bloomberg, Capital Economics

But the PPP Liquidity Facility, which started in mid-April, has purchased only $57bn of the $515bn in SBA-guaranteed loans made to small firms. Loans to municipal governments have also been modest.

At its June meeting, the Bank of Japan raised the size of the lending facilities under its “Special Program” from ¥55tn to ¥90tn. But the amount of loans provided under the new lending facilities launched since March is still far below either ceiling, at less than ¥20tn (or around 15% of GDP). Similarly, borrowing under the Bank of England’s Term Funding Scheme with additional incentives for SMEs (TFSME) has been fairly limited. While banks can borrow up to 10% of their outstanding loans, equating to £200bn or 9% of GDP, they have so far borrowed £12.5bn (or 0.5% of GDP).

However, while some of these results may seem disappointing, it is typically the case that banks and businesses have simply found even cheaper ways to borrow. In all four cases, interbank borrowing rates are now very low, no doubt thanks in part to the knowledge that central bank backstops are available. And the state-backed Paycheck Protection Program (PPP) and Bounce Back Loan Scheme (BBLS), in the US and UK respectively, have allowed firms to borrow on extremely generous (and forgivable) terms. Around $520bn of business loans have been extended under the former and over £20bn under the latter. Accordingly, bank lending growth in all four economies has risen sharply despite the fact that uptake of central bank schemes has been limited in some cases. (See Chart 3.)

Chart 3: Bank Lending to Non-Financial Firms (% y/y)

Source: : Refinitiv, Bloomberg, Capital Economics

It is worth noting again that central bank lending programmes are offering strong support to investor confidence even while their use is limited. We explained in our latest Financial Market Stress Monitor that strains in core money markets have eased further over the past month even as volatility in equity markets has picked up. This is almost certainly because central bank backstops, including lending facilities, have reassured investors that even if the prices of risky assets fall, market functioning will be maintained.

It seems likely that uptake of the various schemes will rise in the months ahead as the newer ones (in the US) become better established and as government schemes are gradually phased out. What’s more, we doubt that the central banks would hesitate to increase their generosity if this was considered necessary to ensure smooth market functioning or to support lending to businesses. Indeed, it is also possible that the private sector lending incentives attached to these facilities will be enhanced. In all, it is clear that central bank lending facilities will play a key role in policy for many months to come.

Recent Monetary Policy Developments

Review of recent policy rate changes

Of the 20 central banks covered in this document, three reduced their key policy rate while the rest were on hold in June. (See Chart 4.) With policy rates close to their floor in advanced economies, the cuts all came in emerging economies, where interest rates averaged 5% coming into the crisis. Brazil cut interest rates by 75bps, Russia by 100bps and Mexico by 50bps last month.

Chart 4: Changes in Benchmark Rates

Source: Bloomberg, Capital Economics

Among the advanced economies, the rapid run-up of central banks’ balance sheets seen in the early stages of the crisis appears to have come to an end for now. (See Chart 5.) The US Fed has been able to slow its Treasury purchases significantly as financial conditions have eased. Meanwhile, all major central banks have run down their emergency liquidity provision, including liquidity swaps with other central banks, as market conditions have improved.

Chart 5: Central Bank Balance Sheets as % of GDP

Sources: Refinitiv, Capital Economics

Looking forward, we expect the ECB to expand its Pandemic Emergency Purchase Programme later this year, and we suspect that the Fed might also have to increase the pace of Treasury purchases to prevent its balance sheet from shrinking. The Bank of Canada and Bank of England also look set to expand their asset purchases, albeit not imminently in the latter.

DM rate cuts no longer in prospect

With a couple of exceptions, we think that interest rates in most advanced economies are now at their floor. Indeed, we expect the Fed, the BoE and the BoJ to keep rates on hold over our forecast horizon. Meanwhile, we have recently dropped our forecast for the ECB to cut its deposit rate later this year as policymakers have shifted their emphasis to longer-term refinancing operations as the best means to promote lending. The exceptions are Sweden and New Zealand where we expect interest rates be cut into negative territory in Q3 and 2021, respectively.

Table 2: Summary of CE Forecasts for Policy Rate
Net Changes by the End of 2020

Policy Direction

Economies

Easing

Sweden, China, India, Brazil, Russia, Mexico, South Africa S

No Change

US, UK, Euro-zone, Japan, Canada, Australia, New Zealand, Switzerland, Denmark, Norway, South Korea, Turkey, Poland

Tightening

Source: Capital Economics

Yield curve control unlikely to take off

With interest rates more or less at their lower bound in the advanced economies, some commentators and central bankers have raised the possibility of yield curve control to limit any rise in long-term borrowing costs. The Bank of Japan has set a target of around zero for 10-year yields since 2016 and the Reserve Bank of Australia announced a 0.25% target for three-year yields this March. In the near term at least, it seems unlikely that other DM central banks will follow in their footsteps. Yields are already very low at maturities as long as ten years in the US, euro-zone and UK and central banks like to maintain an upward sloping yield curve to incentivise lending. But if longer term yields started to rise before the economy was back on track, a target for long-term yields and associated purchases of long-term debt might be a policy that some banks would pursue. We discussed this possibility with respect to the US in our latest Fed Watch.

EMs to loosen more than markets expect

Recent remarks by Yi Gang, the governor of the People’s Bank of China, suggest that bank is reluctant to ease much further and is already considering how to withdraw its COVID-19 stimulus. With China’s economic recovery shaping up fairly well, we now see only marginal policy easing to come.

In contrast, the outlook for other EMs has generally deteriorated and we think that further policy loosening will be needed. We are more dovish than investors about the outlook for monetary policy in Brazil and South Africa in particular. High real rates in Mexico and Russia provide one reason why we expect sizeable policy rate cuts there by year end.

Finally, with nominal policy rates in an increasing number of EMs at or close to the zero bound, more central banks are likely to turn to unconventional policy. Note, for example, that the Bank of Korea recently hinted at a non-explicit target for government bond yields.

Table 3: Central Bank Policy Rates

Sources: Bloomberg, Capital Economics.

Table 4: Quantitative Easing & Other Unconventional Policies

Sources: Central banks, Capital Economics.

Table 5: Calendar of Policy Decisions

Date

Economy

Policy Instrument

Prior

Survey

CE Forecast

7th July

Australia

Cash Rate

0.25

0.25

8th July

Poland

Reference Rate

0.10

0.10

15th July

Canada

Overnight Target Rate

0.25

0.25

16th July

South Korea

Base Rate

0.50

0.50

Euro-zone

Deposit Rate

-0.50

-0.50

20th July

China

7-Day Reverse Repo

2.20

2.20

23rd July

Turkey

1-week repo rate

8.25

8.25

South Africa

Repo Rate

3.75

3.25

24th July

Russia

1-week repo rate

4.50

4.25

29th July

United States

Fed Funds Target Range

0.00-0.25

0.00-0.25

3rd August

Russia

1-week repo rate

4.00

4th August

Brazil

Selic Rate

2.25

2.00

Australia

Cash Rate

0.25

6th August

India

Repo Rate

4.00

4.00

United Kingdom

Bank Rate

0.10

0.10

12th August

New Zealand

Cash Rate

0.25

0.25

13th August

Mexico

Overnight Rate

5.00

4.50

20th August

China

7-Day Reverse Repo

2.20

2.00

Turkey

1-week repo rate

8.25

Norway

Deposit Rate

0.00

0.00

27th August

South Korea

Base Rate

0.50

1st September

Australia

Cash Rate

0.25

9th September

Poland

Reference Rate

0.10

9th September

Canada

Overnight Target Rate

0.25

10th September

Euro-zone

Deposit Rate

-0.50

15th September

Brazil

Selic Rate

2.00

16th September

United States

Fed Funds Target Range

0.00-0.25

17th September

Japan

Interest on excess reserves

-0.10

-0.10

United Kingdom

Bank Rate

0.10

South Africa

Repo Rate

3.00

18th September

Russia

1-week repo rate

3.75

21st September

Sweden

Deposit Rate

0.00

Sources: Bloomberg, Capital Economics


Jennifer McKeown, Head of Global Economic Service, jennifer.mckeown@capitaleconomics.com
Gabriella Dickens, Assistant Economist, gabriella.dickens@capitaleconomics.com