The Bank of England can’t prevent the economy from falling into recession. But like the Fed, we think it will soon throw everything in its policy arsenal at the coronavirus crisis to try to prevent the markets from seizing up and to reduce the risk of a more prolonged downturn.
- The Bank of England can’t prevent the economy from falling into recession. But like the Fed, we think it will soon throw everything in its policy arsenal at the coronavirus crisis to try to prevent the markets from seizing up and to reduce the risk of a more prolonged downturn.
- The Bank of England has already cut interest rates by 50 basis points (bps) from 0.75% to 0.25%, launched a Term Funding Scheme with additional incentives for Small and Medium-sized Enterprises (TFSME), reduced the countercyclical capital buffer from 1% to 0% and, in a coordinated move with other central banks, announced more lines of US dollar liquidity for banks. (See here.) But faced with the growing possibility that the coronavirus crisis could spiral into a full-blown financial crisis, more will probably be needed.
- Before of all of the above, the Bank estimated that it had 200-250bps of total conventional and unconventional policy room. Last week, Bank Governor Andrew Bailey said that the Bank had now used up half of the room, leaving it with 100-125bps of ammunition. A further 15bps cut in rates to the Bank’s current estimate of the effective lower bound of 0.10% would leave it with 85-110bps of policy room.
- Previous Governor Mark Carney said that the Bank has room to “at least double the August 2016 package of £60bn asset purchases”, which the Bank estimates would be equivalent to a 100bps rate cut. Admittedly, there are big question marks over how effective another bout of quantitative easing (QE) would be. As the 10-year gilt yield has already fallen below 0.50%, there is less scope to drive yields lower. But the government’s fiscal stimulus means there is a greater supply of gilts to mop up. And the purchases could push investors into holding other assets, thereby depressing the yields on those assets as well. QE would be more effective if the Bank also bought riskier assets, such as corporate bonds. That would be useful as corporate bond yields have shot up. Bringing them back down would lower borrowing costs for businesses.
- As a result, we expect the Bank to do very soon what it took it months to do in the wake of the 2008/09 financial crisis. We’re expecting £150bn of asset purchases (£120bn of gilts and £30bn of corporate bonds) probably spread over six months. The Bank could either announce it as a one-off package or as an open-ended commitment to buy £25bn of assets a month. If so, at this point the Bank may have exhausted all its estimated policy ammunition.
- The Bank could also beef up the efficacy of lower rates by issuing some verbal guidance. The Bank’s last foray into state-contingent guidance in 2013, in which it committed to not raise interest rates until the ILO unemployment rate fell below 7%, was not a success. But like the Fed, the Bank could signal that monetary policy will remain on hold until there is clear evidence that inflation has returned sustainably to the 2% target.
- Admittedly, the Bank could do even more. As the supply of gilts is set to increase, it could always do more QE. And in extreme circumstances, it could cut rates into negative territory or implement yield curve control by committing to keep 10-year gilt yields close to 0%. It could even give serious consideration to Modern Monetary Theory (MMT), which would be akin to “helicopter money” as a fiscal expansion would be permanently funded by printing money. (See here.)
- But there is a limit on what monetary policy can achieve. The Bank can prevent a severe liquidity squeeze in the money markets and provide short-term assistance to banks who need cash. It can also support the eventual recovery in demand. But it can’t force banks to lend to failing firms. That will require a commitment from the government to guarantee banks loans to vulnerable businesses. (See here.)
- Overall, there are two reasons why the Bank will probably be more proactive than during the 2008/09 financial crisis. First, while the behaviour of the banks partly caused the financial crisis, as no one is to blame this time it is easier to support them. Second, the financial crisis taught policymakers that there are advantages of moving quickly and boldly. That’s why we expect the Bank will all-but empty its locker at the next MPC meeting on 26th March, if not before. Beyond that, the responsibility for making sure the economic fallout from the coronavirus doesn’t spiral into a lengthy recession lies with the government.
Ruth Gregory, Senior UK Economist, +44 7747 466 451, firstname.lastname@example.org