March 11, 2020 will probably be remembered as a shining moment for the Bank of England, a day when the institution demonstrated how monetary policy should be done in a time of crisis. In fact, alongside the UK government (which released a highly stimulative budget), the BoE has jointly demonstrated how macroeconomic policy, i.e., monetary and fiscal policy coordination, should be done in a time of crisis. Admittedly, there was a fortuitous element present in that a budgetary announcement had been already scheduled for today, so the stage had been set and ready for timeliness and coordination. Nevertheless, the manner in which this coordination has taken place, with full partnership, shared purpose, and mutually re-enforced effectiveness, stands in contrast to situations elsewhere, where either fiscal and monetary authorities experience strained relations (with blame assignations ever-present) or are more institutionally constrained from undertaking effective action. Frankly, we wish that both US and eurozone authorities could display a similar degree of coordination. The lessons aren’t the same for the two areas, but there are lessons here nonetheless.
So, what has the Bank done? For starters, it announced a unanimous inter-meeting emergency rate cut of 50 basis points, bringing the bank rate to 0.25%. Given similarly sized moves by both the Fed and the Bank of Canada last week, this may perhaps not seem surprising. But the BoE has actually done something that neither the Fed nor the BoC had managed, which was to heavily exceed market expectations in terms of the size and timing of the cut. Markets had already priced-in the Fed move by the time it was announced, and they had also already priced-in the BoC’s move before it was announced. Not so with the Bank of England: Not even a 25-bp rate cut was fully priced-in for the March 26 meeting as of yesterday. Instead, we got twice as much and two weeks early. Bravo!
We were even more heartened by the other measures announced today:
A new term funding scheme (so called TFSME) that, over the next twelve months, will make available four-year funding equivalent to at least 5% of participants’ stock of real economy lending at interest rates very close to the bank rate. There are special incentives for lending to small and medium sized firms in an effort to ensure today’s rate cut feeds through to the real economy. The facility could release in excess of £100 billion in term funding.
A reduction in the counter-cyclical capital buffer from 1% to 0%. In reality, the value of the announcement is twice as much because the buffer was actually slated to go up to 2% by December. This is estimated to support up to £190 billion of bank lending, thirteen times the amount of banks’ net business lending in 2019.
New supervisory guidance and expectation that “banks should not increase dividends or other distributions, such as bonuses, in response to these policy actions.”
Conspicuously absent among the measures announced? An expansion in the stock of UK government bonds purchased, which was kept at £435 billion. We are glad to see this unchanged because the sort of shock to which the BoE is responding requires a speed of transmission to the real economy that buying more government bonds simply cannot deliver.
In short, we look at today’s BoE package as exactly the sort of action that can prove effective under the circumstances. Unsaid but readable between the lines is an implicit expectation that it will require heavy limitations to the movement of people in order to bring the Covid-19 outbreak under control. Therefore, the short-term economic costs could be quite severe, even if temporary. As such the bank is focusing its energy on things that, as Governor Carney noted during the press conference, will “keep firms in business and people in jobs.” The bank dividend and bonus bit in the package also struck us as a clever way of getting both to the banks’ potential temptation as well as the frequent criticism that rate cuts don’t work because banks simply take the lower funding costs and pass them on to their own shareholders without benefitting the real economy.
In short, there was a lot here that may yet come to be seen as a template for effective central bank policy action at times when a dual supply and demand shock hits. We concur with Governor Carney’s view that while during the great financial crisis, the banking system was “the core of the problem,” in this crisis, it can be “part of the solution.”
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