King May Abandon Bank-Aid Reticence as Slump Worsens
Bank of England Governor Mervyn King may abandon his reticence to shore up the financial system as the economy slides deeper into a recession.
With the central bank set to cut the U.K.’s key interest rate to the lowest in history this week, King may soon be forced to follow the Federal Reserve and pursue other ways to pump money into an economy contracting for the first time since 1991.
King’s first course of action will probably be to expand the 200 billion-pound ($290 billion) program that allows banks to swap illiquid securities for government debt, economists say. That would suggest he will be more aggressive in helping banks after criticism from executives and former policy makers that he was too focused on the dangers of reckless lending.
“The balance between moral hazard and doing what’s necessary to get the economy back on track is shifting,” said Nick Kounis, chief European economist at Fortis in Amsterdam and a former U.K. Treasury official. “King has made a big deal in the past about not being too generous, and it would be quite a big U-turn for him.”
King’s Monetary Policy Committee will on Jan. 8 reduce its main rate to 1.5 percent from 2 percent, according to the median of 50 forecasts in a Bloomberg News survey of economists.
That would be the lowest since the bank was founded in 1694 to finance King William III’s war against France. The European Central Bank’s benchmark stands at 2.5 percent. Rates in the U.S. and Japan are close to zero.
Blame
King has been under fire since the credit crisis started in 2007 for being too slow to help the banking system. Lawmakers criticized the Bank of England, along with the government and regulators, for not doing enough to soothe the market tensions that led to the collapse of Northern Rock Plc.
In September, King refused to extend the Special Liquidity Scheme beyond its original October deadline until the collapse of Lehman Brothers Holdings Inc. forced him to reverse his decision. The program now runs until Jan. 30.
King “must shoulder some of the blame” for the near- collapse of mortgage lender HBOS Plc in the subsequent market turmoil, Keith Skeoch, chief executive officer of Standard Life Investments Ltd., said in September. Former policy makers Charles Goodhart and Willem Buiter have said it was a mistake for King to put any deadline on the liquidity program.
“I would hope they’ll be more generous,” said Michael Saunders, chief Western European economist at Citigroup Inc. in London. “I would hope they’d realize the cost of the emphasis on moral hazard is to throw a lot of fairly blameless households and businesses to the recession cash advance no faxing.”
Recession
The Bank of England is now stepping up its response and joining Prime Minister Gordon Brown in encouraging banks to resume lending. British house prices lost almost a fifth of their value last year, HBOS said Jan. 2, and manufacturing contracted for an eighth month.
Brown said yesterday his government will create up to 100,000 jobs and push banks to extend more credit to companies.
U.K. officials cut their main rate by 1.50 percentage points in November, the most since 1992, and have reduced it by a total of 3.75 percentage points since December 2007.
The dilemma facing King and other central bankers is that near-zero interest rates and still-frozen credit markets mean monetary policy now packs less of a punch, forcing them to look for other methods to spur lending.
Rate Cuts
Fed Chairman Ben S. Bernanke on Dec. 16 cut the rate for overnight loans between banks to a target range of zero to 0.25 percent, and the Fed said it would buy unlimited quantities of securities. Three days later, the Bank of Japan lowered the overnight lending rate to 0.1 percent from 0.3 percent and decided to buy corporate debt for the first time.
Bank of England officials may not be far behind after last month identifying a need “for further measures to underpin lending growth.” One option is to loosen the Special Liquidity Scheme’s terms by reducing the fees banks pay to participate, said David Tinsley, an economist at National Australia Bank in London.
King could also widen the range of securities that can be swapped beyond those originated before 2008 or scrap the program in favor of a bigger arrangement.
“The bank has been quite sharp in trying to keep some kind of moral hazard considerations,” said Tinsley. “Cutting the fees and removing the deadline for origination would be a powerful way of boosting liquidity.”
King told lawmakers in November that the Bank of England would cooperate closely with the Treasury were rates to fall close to zero.
Greater willingness by King to step beyond conventional tools shows the change in his thinking, says Roger Bootle, founder of Capital Economics and a former adviser to the U.K. Treasury.
“King’s been on a remarkable intellectual journey over the last year or so,” he said. “He probably placed too much emphasis on moral hazard for too long. I don’t think you can accuse him of conservatism after what he’s been saying recently.”