Bank of England’s Brexit Plan Challenged by Global Surge of Cheap Money – Reuters

By David Milliken

LONDON – The Bank of England’s recent rate cut—its first since 2009—may not fully benefit borrowers, despite the central bank’s willingness to lend banks up to £100 billion to facilitate this change.

The introduction of the Term Funding Scheme (TFS), which marks the Bank’s most significant intervention in the UK banking sector in four years, is expected to provide only a modest enhancement to economic growth. It also underscores the complexities of implementing interest rate reductions as they near zero.

Governor Mark Carney emphasized that lenders had "no excuse" not to pass on the recent quarter-point reduction to a 0.25 percent interest rate, as the TFS aims to offset any negative effects on bank profits by supplying inexpensive loans to banks.

However, complications have emerged just days after the announcement, with major mortgage lender Lloyds Banking Group opting to maintain its primary rate and First Direct, a subsidiary of HSBC, lowering the interest rate on one of its savings accounts by 0.4 percentage points.

"The narrative presented was a bit simplistic," stated Ian Gordon, a banking analyst at Investec.

Key factors impacting the situation include the wide variation among British lenders regarding their ability to reap benefits from the TFS. This variance is largely influenced by each lender’s existing access to financing that is cheaper than the TFS’s minimum charge of 0.25 percent.

Larger institutions such as Royal Bank of Scotland, Barclays, and HSBC often find themselves with more cash than they can lend, typically sourced from business and personal accounts that require little or no interest payout. For these banks, the TFS is unlikely to alleviate the pressure on their net interest margins, which are crucial for their lending profits.

Consequently, interest rates on new two-year fixed-rate mortgages—the most popular form of home financing in the UK—are expected to drop by less than 25 basis points. Gordon indicated that while he anticipated a decrease in prices, he was doubtful that rates would reduce to the full extent of the cut.

Existing mortgage rates that are linked to the Bank Rate are likely to decrease, but credit card rates and new business loans—more sensitive to the economic environment—may remain sticky.

Bankers argue that Lloyds and smaller competitors like Virgin Money, Shawbrook, and Aldermore could benefit more from the TFS since they rely on more expensive wholesale financing and savings accounts.

Gordon mentioned that these smaller lenders might have the flexibility to lower the interest rates they pay on savings accounts by more than a quarter percentage point—an outcome of the TFS that the Bank has not emphasized.

Modest Gains

This does not imply that the TFS is ineffective; however, its impact may not match the significance of the Bank’s last major intervention, the Funding for Lending Scheme (FLS) of 2012.

Samuel Tombs from Pantheon Macroeconomics commented that while the TFS could provide some economic stimulus, it is not a transformative measure. The FLS was initiated during a time when UK banks were facing elevated borrowing costs linked to the eurozone crisis and offered incentives for lending as the economy began to recover.

In contrast, the TFS comes at a time when banks can already obtain financing at lower costs. The Bank anticipates that both business and housing investments will decline significantly, which could reduce the demand for loans.

Deputy Governor Ben Broadbent noted that the current conditions reflect a healthier banking environment, indicating that the credit supply is not the primary constraint on the economy. He asserted that there’s little value in offering intense incentives for lending if they would likely go unused.

The £100 billion in newly created funds available through the TFS accounts for about 5 percent of outstanding UK loans, with a significant portion potentially being used by banks to refinance existing FLS loans at lower rates.

Broadbent remarked that the full effects of the recent rate drop would take time to materialize, and the Bank would not monitor every single loan rate but would instead depend on competitive market pressures to reduce borrowing costs.

Some economists, like J.P. Morgan’s Allan Monks, have speculated that the TFS could pave the way for negative interest rates indirectly, despite Carney’s opposition, suggesting it might effectively incentivize banks to lend.

However, Broadbent quickly dismissed this idea, referencing the challenges faced by a similar European Central Bank initiative in encouraging banks to offer deposits or loans at negative rates.