Carney’s final fusillade
THE middle of a global health emergency is no time to fight old arguments about the eurozone.
Nevertheless, not being part of the eurozone confers great independence of action on the Bank of England.
This was true in 2008 at the height of the financial crisis when then Governor Mervyn King – having learnt some lessons from the rehearsal that was the Northern Rock collapse – came up with a plan for acomprehensive recapitalisation of the banking system and monetary measures designed to ease the severity of the recession which followed.
The scope for the UK to set its own monetary course was on full display on Budget Day 2020. The Bank of England was able to take the same kind of decisive steps it took in 2008 and after the EU referendum in June 2016 to support output.
The departing Governor Mark Carney, with his successor Andrew Bailey at his side, was able to point out that in 2008 the financial system was the problem but with the Covid-19 crisis it is able to be part of the solution. That is strictly correct with the substantial £290bn of direct help to business that has been identified.
Bailey will be aware that there is no room at all for complacency. As a senior Bank of England official, he was in the engine room when Lehman Brothers collapsed, triggering defaults across the global financial system and bringing UK banks to their knees.
In 2008-09 it was the unexploded bomb of repackaged mortgage securities that brought the financial system to the brink.
Often in finance it is an unexpected event such as Covid-19, which has not been fully gamed, that has consequences which lead to a chain reaction.
As has been noted on these pages, the International Monetary Fund’s most recent global stability report calculated that there is up to £15trillion of corporate debt around the world which borrowers will struggle to repay. As in 2008, some of these risky loans have been turned into complex securities and nobody is quite sure where they are lurking.
A health epidemic, if sustained, could potentially provoke a new crisis for lenders. Central banks have moved rapidly to prevent this happening. The Federal Reserve, the Australian and Canadian central banks and now the Bank of England have slashed interest rates.
The Bank’s half-a-percentage point reduction in bank rate to 0.25pc is more dramatic than most analysts expected. It also showed that it was wise for Carney and the interest rate setting Monetary Policy Committee to hold CENTRAL its fire until serious trouble loomed.
bank actions primarily are designed to assist domestic enterprises in the air travel, tourism, leisure and small business sectors – all suffering cashflow problems because of coronavirus – by lowering most interest rate bills.
There is no better illustration of the kind of savings possible than Rishi Sunak’s Budget, which shows that lower rates have reduced the cost of government borrowing over this Parliament by £37bn.
The European Central Bank (ECB) has still to act and the first big test for Christine
Lagarde as president comes today. The former IMF managing director is under acute pressure to provide some assistance.
The eurozone was already struggling before the virus, which is proving a nightmare for Italy.
A substantial UK-style rate cut is not on the cards because ECB rates are in negative territory. Some City analysts are suggesting that one-tenth of one full percentage point is possible.
As likely is a temporary increase of quantitative easing – printing money – or more direct help to the banking system.
Even in the most extreme circumstances this is not easy for the ECB because of the German creed of sound money.
The most practical part of the Bank of England’s approach is the £100bn special facility earmarked for small businesses facing cashflow difficulties.
By requiring the High Street banks to store up capital in the good years the Old Lady was also able to relax the rules so that the banks will be able to lend £190bn more to the corporate sector.
Sensibly, the Bank does not see this as a free gift to overpaid bankers or their shareholders. The stipulation that earnings arising from the capital release should not be used for bonuses or dividend payouts sets a great governance precedent.