Bank of England acts to boost bank lending, warns on Brexit fallout
The Bank of England has loosened UK bank's requirements to hold extra capital and warned that risks from the country's Brexit vote had already started to "crystallise".
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In its twice-yearly Financial Stability Report, the Bank looked to encourage banks to keep lending by trimming the countercyclical capital buffer rate to 0% from 0.5% with immediate effect and until at least June 2017.
The Bank said the cuts to capital buffers will raise banks’ capacity for lending to UK households and businesses by up to £150bn.
The BoE, which in March had said the capital buffer would rise to 0.5%, said it expected banks not to increase dividends and other payments, such as bonuses, as a result of the reduced capital buffer.
Led by Governor Mark Carney, the Bank's Financial Policy Committee (FPC) monitored a range of risks, including the UK's large current account deficit, swollen commercial property market, high levels of household debt and subdued and fragile global economies and markets.
"There is evidence that some risks have begun to crystallise," the report said. "The current outlook for UK financial stability is challenging."
The Bank also said it stood "ready to take actions that will ensure that capital and liquidity buffers can be drawn on as needed, to support the supply of credit and in support of market functioning”.
Carney speech
In his press conference after the release of the report, Carney looked to reassure that the Bank was willing to act swiftly if needed post-Brexit.
The Canadian also pointed out that the central bank was able to provide substantial FX liquidity if required, adding that its regulatory framework allowed up to half of capital in all liquidity buffers held by banks to be used if needed.
But with speculation rife that the bank may adjust interest rates from their current 0.50% low, Carney said it was “extremely important that any monetary action is well aimed” and “should consider unintended consequences”.
He added that the fall in the pound, which after disappointing news on UK service PMIs hit a new 31-year low of 1.3113 against the dollar shortly before the report's release, will help to support UK exporters.
But the Governor said while the Bank was putting its plan into operation, it could only do so much and "cannot fully offset the economic and market volatility".
In answer to a question, Carney also assured that there will be no immediate changes to UK financial regulations until Britain has actually left the EU.
The Bank's Financial Conduct Authority was also said to be in “very close touch” with firms in the real estate sector, after Standard Life suspended redemptions in its UK property fund.
FCA chief Andrew Bailey said the move prevented a stampede of money out of property funds while the underlying assets are revalued, which could mean some investors were at the front of the queue to get their money back, while those at the back would lose out.
Risks identified
Having earlier identified several risks around the UK's referendum on membership of the European Union, the report noted prices of real estate investment trusts have fallen sharply recently.
There was particular concern expressed that the current account deficit could swell further and that the commercial real estate market was already seeing pressure, as demonstrated by the Standard Life news overnight.
"The financing of the deficit is reliant on continuing material inflows of portfolio and foreign direct investment, which have been used to finance the public sector deficit and corporate investment, including in commercial real estate.
"A sudden shift in the supply of foreign capital and in the current account deficit would be associated with a sharp increase in risk premia and adjustment in sterling.
As strong inflows of overseas capital have inflated the commercial property market, with foreign investors accounting for around 45% of the value of total transactions since 2009, valuations, especially in London's prime market, have become stretched and foreign inflows of capital to this market fell by almost 50% in the first quarter of 2016.
"More recently, share prices of real estate investment trusts have fallen sharply, reflecting the risk of future marked adjustments in commercial real estate prices," which is significant given the Standard Life news.
You can lead a horse to water...
Lending volumes depend on demand as well as supply, observed Ben Brettell, economist at Hargreaves Lansdown, so while the bank has given banks more capacity to lend, highly indebted UK households have already become more risk averse due to the referendum and so "the demand for credit simply won’t be there, however much the banks are willing to lend".
Economist Howard Archer at IHS Global Insight said Carney’s comments "suggest that he himself would be reluctant to take interest rates any lower than 0.25% from the current level of 0.50%" and that the Governor certainly seems against negative interest rates.
"On the monetary policy front, we strongly suspect that the Bank of England will cut interest rates from 0.50% to 0.25% at either its July or August meeting," Archer said.
"We also suspect that the Bank of England will extend its Funding for Lending Scheme and it may very well also return to quantitative easing, which has been on hold since November 2012 with the stock of purchases at £375bn."
He acknowledged that exactly what the Bank's rate setting committee will do and when is slightly clouded by the fact that Carney has indicated that the July and August MPC meetings should be seen as a “package”.
"The Governor has indicated that the MPC will make an initial assessment of the situation now facing the UK economy at their 14 July policy meeting and a full assessment complete with new forecasts at their August meeting, which coincides with the release of the new Quarterly Inflation Report. The Governor has also stated that at the August meeting that the MPC would discuss further the range of instruments at their disposal."