Bank’s intermeeting cut phase one in today’s coordinated policy response

David Page, Senior Economist at AXA Investment Managers, comments on the latest developments at the Bank of England:

• BoE delivers a “big package” of measures, estimated to provide “north of 1%” of GDP stimulus to the UK economy, part of a coordinated move with today’s Budget, where fiscal easing is expected.
• The BoE cut Bank Rate to 0.25% (-50bps) and introduced a Term Funding Scheme – cheap four-year money for banks to help them pass low rates on to the real economy.
• The FPC also eased the Counter-cyclical Buffer (CCyB) on banks to 0% from 1%, a move estimated to back £190bn of lending to the real economy.
• The Bank stressed that it had not exhausted its policy options and will take all necessary further steps.
• The policy outlook is highly uncertain from here depending on the spread and impact of Covid-19, international policy responses and financial market reaction.
• We cautiously assume additional easing from the BoE, but only at May’s Monetary Policy Meeting, when we expect Bank Rate to fall to a lower bound of 0.10% and renewed QE.   

The Bank of England (BoE) announced a “big package” of measures this morning in an intermeeting decision designed to be coordinated with the UK Budget announcement at 12.30 (GMT) today. The measures were designed to combat the global outbreak of Covid-19 that was expected to deliver “an economic shock that could prove sharp and large but should be temporary”. Governor Carney and incoming-Governor Bailey held a joint press conference, where Carney stressed that the “direction” of the impact on the economy was clear, but that the “order of magnitude was less clear”. The Bank’s package of measures was co-ordinated across the range of its areas of oversight and included: -

• Bank Rate reduced by 50bps to 0.25%. This was the first 50bps rate cut since 2009.
• A Term Funding Scheme with additional incentives to SMES (TFSME). This allows commercial banks and building societies to borrow four-year cash directly from the BoE (secured, in exchange for eligible collateral) at rates close to Bank Rate. Banks will be eligible to borrow up to an amount of 5% of their total net lending position, plus any increase in lending to households and five times any increase to SMEs. Lending will be at Bank Rate plus a fee, determined at 0bps where net lending increases across 2020, but rising proportionately from 0-25bps where lending falls by 5%. This is similar to the TFS scheme the BoE introduced in 2016, which the Governor described as “very effective”. As with the TFS, the BoE will expand its balance sheet, creating reserves to fund this operation. Based on previous experience, the BoE states that this policy could create over £100bn of funds for lending. The policy is designed to help reinforce the transmission of monetary policy at times of low rates, to provide insurance against adverse lending conditions and to incentivise banks to provide credit to households and businesses to help bridge the period of economic disruption.     
• A reduction in the Country Cyclical Buffer (CCyB) to 0%, from 1%. As recently as December, this buffer had been signalled to rise to 2% by the end of this year. The BoE stated that this reduced requirement for banks to hold capital would “support up to £190bn of bank lending to business”. The BoE stated that this was 13 times the total net lending to business in 2019. Governor Carney stressed that this was a material piece of today’s policy package. The BoE stressed that the last decade had seen a rebuilding of the strength of the resilience of the financial system and that these buffers were “there to be used”. This, Carney said, meant that during this time the financial system could be part of the solution, not the core of the problem. Bailey added that the BoE would also conduct “consistent and constructive monitoring” of how banks manage their capital.
• At the same time the BoE’s Prudential Regulation Committee (PRC) announced that capital should not be distributed through other means (increases in dividends or bonuses).  

Two questions remain after today’s comprehensive package of measures: what’s left, and when might it be deployed?

Governor Carney gave evidence to the Parliamentary Committee where he suggested at that time that the BoE had the capacity to deliver around 200-250bps of easing in monetary policy through a combination of interest rate cuts, asset purchases, forward guidance and other measures. After today’s measures the Governor suggested that about half of that capacity had been used. However, he stressed that this estimate is in some part based upon current financial market conditions and that these could shift, changing the estimate of what future policy could do.

We consider the scope for additional policy easing as limited.

• Governor Carney repeated that the BoE could reduce Bank Rate further to “close to, but slightly above 0%”. He did not correct a question that suggested that 0.10% might be the low. This suggests a small, further 15bps of additional conventional policy could be deployed.
• Unconventional policy could again be limited depending on financial market conditions. This is immediately obvious through forward guidance, where the policy’s ability to affect market rates depends on what markets already expect. With markets currently pricing Bank Rate below the current level in four years’ time, a further boost through forward guidance is likely to be limited at this stage.
• Similarly, quantitative easing has a large impact through the reduction of longer-term rates. However, with 10-year gilt yields currently at 0.28% and close to an expected lower bound in rates, additional stimulus through this avenue may also be limited.
• The Bank could increase its asset purchases through increased corporate bond purchases (currently at £10bn). However, the size of the UK corporate debt market limits the quantum of this policy, albeit that the price effect could be greater.
• The BoE could also increase the size or duration of its TFSME, potentially shifting the sectoral lending incentives. However, this policy is fundamentally limited by the demand for borrowing. While economic distress can create a short-term demand for bridging finance and working capital, lending more generally is typically pro-cyclical used to finance long-term consumer and business spending. It will be difficult for banks to increase lending if a more protracted weakening of activity develops, regardless of incentives to lend.   

In all instances, the more optimistic the market outlook, the more scope the BoE has to provide additional stimulus, but the converse is also true. This is in part why the BoE decided to move assertively today and, as Governor Carney explained, to maximise the effectiveness through coordination of each of its different wings of policy and with government in terms of the expected fiscal stimulus later today.

Governor Carney described today’s package of providing “north of 1ppt of GDP”’s worth of stimulus. This comes on top of fiscal stimulus that we expect to provide a near-term easing of around 1½ppt of GDP. If we are correct, this provides a material boost to the UK economic outlook, which would not address the “worst case” scenarios for the Covid-19 outbreak impact, but certainly addresses a large range of worse-case scenarios. In that sense, we do not expect the Bank of England to ease policy again on 26 March. Incoming Governor Bailey stated that as well as considering fresh real-time evidence, surveys and anecdotal evidence before the next meeting, the assumptions that conditioned today’s actions could also change over the next fortnight. He stressed that every meeting was live. However, for now, we think the more important meeting will now be the 7 May Monetary Policy Report meeting. We will have a much better understanding of the path of the Covid-19 spread by then and the BoE will be better placed to bed this assessment into a more formal forecast for the economic outlook. As important as the spread of the virus will be the scale of international reaction. Coordinated action today is going to prove an important boost to the UK economy, assuming a fiscal boost in line with our expectations. However, the UK economy is still highly integrated in the global economy. If other global economies provide stimulus along the lines of the UK’s stimulus, there should be good grounds to see recovery as the shock of the virus dissipates. However, future BoE moves will depend on the path of the virus, the international policy reaction and financial market expectations. For now, we remain cautious, and expect further monetary easing, likely to include a reduction of Bank Rate to 0.10% and a restart of corporate and sovereign QE at May’s meeting.

While the timing of the BoE’s move was unexpected, markets had been expecting some reaction, which has muted the overall reaction today. Markets currently price a 50% chance that the BoE cuts Bank Rate again in March, if not, a modestly larger chance of a cut is seen in May, in line with our outlook. 2-year gilt yields fell back to 0.10% immediately after the move (from 0.14% yesterday) but have risen back to 0.12%. 10-year yields have actually risen by 4bps on yesterday’s close to 0.28%. Sterling fell back by around 0.8% against both the dollar and euro but recovered most of those losses to the US dollar and has appreciated to the euro, as expectations about what the ECB might deliver tomorrow rise.