The big package of measures announced by the Bank of England today in its second emergency meeting in just over a week is designed to ease the stress in the financial markets and to support the recovery once the full economic hit from the coronavirus has been felt. So far it has only reduced gilt yields by 10-15 basis points, so the Bank may have to do even more at its next meeting on Thursday 26th March.
- The big package of measures announced by the Bank of England today in its second emergency meeting in just over a week is designed to ease the stress in the financial markets and to support the recovery once the full economic hit from the coronavirus has been felt. So far it has only reduced gilt yields by 10-15 basis points, so the Bank may have to do even more at its next meeting on Thursday 26th March.
- The further cut in interest rates, from 0.25% to what the Bank considers the lower bound of 0.10%, won’t do much. But the increase in quantitative easing (QE) by £200bn is impressive and is directly aimed at reducing the spike in gilt yields in recent days that at one point earlier today took 10-year gilt yields above 1.00% for the first time in ten months. (See Chart 1.) At a time when major central banks are slashing rates to zero, that’s a worrying sign that the financial markets are failing to function as they should.
- That £200bn is at least as large or bigger than the QE packages announced in 2009 (£200bn), 2011-12 (£175bn) and 2016 (£70bn). It increases the size of the Bank’s existing asset holdings by 45%, from £445bn to £645bn. And it is worth about 9% of GDP, which is bigger than the asset purchases of 3.3% of GDP and 7.3% of GDP announced by the Fed and the ECB respectively in recent days. The purchases will also be completed as soon as is “operationally possible”. If they were completed over three months, it will eclipse both the size and the pace of the monthly purchases in previous rounds of QE. (See Chart 2.)
- What’s more, the Bank also said today it would increase the amount banks can borrow from its Term Funding Scheme with incentives for small and medium-sized enterprises (TFSME), from a initial 5% of their outstanding loans to 10%, suggesting the amount borrowed could end up being over £200bn, double the Bank’s previous estimate of £100bn. This and the previously announced new Covid-19 Commercial Paper Facility, which is unlimited, will both be financed by central bank reserves. Both of these are designed to make more funding available to businesses. So the Bank is willing to use its balance sheet to address the stresses in the financial markets and to get money flowing to those businesses that need it.
- However, the £200bn of extra QE has so far only reduced gilt yields by 10-15 basis points across the curve, so the Bank’s work may not be done yet. Should the financial stresses worsen between now and next Thursday’s policy meeting, the Bank could pivot from a set amount of QE towards yield curve control, which would require it to buy as many gilts as needed to keep 10-year gilt yields close to 0%.
- More serious consideration may also be given to the possibility of a “helicopter drop” – government spending/tax cuts financed by a permanent increase in the money supply. That would mean the government can announce further measures to support businesses and households without government debt rising. Meanwhile, the prospect of large-scale job losses and below-target inflation might yet cause it to change its mind on reducing interest rates below zero.
- Overall, the Bank has shown that it is willing to act aggressively to support the economy and try to ease the stress in the financial markets in order to stop the economic crisis from morphing into a bigger financial one. If that risk rises further, we suspect the Bank will have to test its more unusual tools.
Chart 1: Gilt Yields (%)
Chart 2: BoE Asset Purchase Facility
Sources: Bank of England, Capital Economics
Ruth Gregory, Senior UK Economist, +44 7747 466 451, firstname.lastname@example.org