The Bank of England has tied one hand behind its back in ruling out negative interest rates but has at least managed to grasp an effective bludgeon with the other.
The new weapon, at least new to Britain, is the Term Funding Scheme, a plan to give banks up to £100bn of loans at advantageous terms so long as they lend the money on to businesses and consumers.
Not dissimilar from programs used by the European Central Bank, the TFS may help to cut the knot at the center of monetary policy near and below zero rates: how to ease further without undermining the financial system.
Struggling with an economy stalling after the shock of Britain’s June 23 vote to leave the European Union, the BOE on Thursday cut rates by a quarter percentage point to 0.25%, increased and broadened quantitative easing, and unveiled the TFS.
At the same time BOE Governor Mark Carney appeared to rule out negative interest rates, a tactic which has met with mixed success and caused a good deal of discomfiture among financial institutions in Japan, Switzerland and the eurozone.
“I’m not a fan of negative interest rates,” Carney said, adding that he “cannot see any scenario where I would consider negative interest rates.”
Carney has previously characterized negative rates as an attempt at currency devaluation which simply moves demand from one place to another, rather than increasing the sum total of demand.
Negative rates are also problematic for banks and insurers, both of which depend on profiting from a spread between the rate at which they fund themselves and what they can charge borrowers.
It is this issue which TFS attempts to address. UK banks will be able for the next 18 months to access four-year central bank loans at rates close to the BOE’s Bank Rate. Should they reduce their net lending they face a penalty rate. They therefore should be willing, given sufficient demand, to make loans even as the BOE cuts rates.
This may even obviate the need for negative interest rates, as the BOE could continue to ease funding conditions, and impose penalties, for and on banks despite the apparent barrier of the zero lower bound.
If the BOE eases again by 25bp, of course, its key rate will be at zero.
Nice policy, pity about demand
TFS doesn’t, on the other hand, do that much to stoke demand. Two observations seem reasonable. First, even if banks cut loan terms, borrowers have to believe the projects or consumption backed by the loan will be justified by future cash flows. Given the uncertainty around Brexit and the UK economy, the psychological hurdle rate for UK borrowers is probably quite high right now.
Secondly, fiscal policy would work a lot more effectively than monetary policy right about now, or rather fiscal stimulus would make monetary policy like the TFS much more effective. What happens on the fiscal side remains to be seen but Brexit is both a reason and a constraint.
It is also an irony that TFS will support housing prices in Britain without doing anything to increase supply, potentially re-stoking a bubble which is both economically sterile and distorting.
Yet the TFS is potentially powerful, because it allows the BOE not just to control the price of credit it makes available to banks but also the duration of the loan. In a July discussion of ECB use of similar policy, Eric Lonergan, of M&G Investments, gives the example of how the central bank might make money available for negative 5% yields for 20 years to back durable goods loans.
“Would it work?” Lonergan wrote on his personal blog. “Just watch the share prices of automakers!”
While the TFS finesses certain limitations of negative or very low interest rates, it does so by involving the central bank in picking winners and losers in the economy. One obvious winner is the banking system, which benefits, not just from the loans, but enormously from the perception the policy makers will keep them in profits.
The TFS will tend to back certain types of lending, particularly mortgage rates.
And, as the money for the TFS is created by the BOE, it is both very like helicopter money and a program which could be used to create permanent financing.
For these, and other reasons, don’t expect this to be a plan the Federal Reserve uses soon. The accusation of picking winners and losers seems to carry more shame with it in the US.
Still, TFS gives the BOE more control even in current extreme conditions and avoids some of the costs of negative rates.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
