Here’s what the Bank of England is doing to tackle coronavirus
The Bank of England has cut interest rates by 0.5 percentage points to just 0.25%. John Stepek explains how this could help tide the economy over the period of coronavirus disruption.
Budget Day has started with a bang. The Bank of England has followed the Federal Reserve, and announced an emergency interest rate cut, from 0.75% to 0.25%. Rates are now back at their post-financial crisis record low. What will that do? Quite probably not very much on its own.
As we’ve pointed out before, if people haven’t been investing or spending with the base rate at 0.75%, a half-point cut won’t make the difference. And right now, what we’re facing is very different.
The risk from coronavirus is that a significant part of the economy is effectively mothballed for three months or more. We’ve already seen that happen in the travel industry and it’s going to spread as we all start to self-isolate. A cut to the cost of credit won’t make a blind bit of difference there. In fact, it’s mostly just showbiz.
You cut rates energetically at the start of Budget Day to set the scene. You grab headlines. You make it very clear that the government is “DOING SOMETHING” – which matters, as there was definitely a sense in the air that the populace was starting to get a bit restive on that front.
The immediate problem for businesses is liquidity, not solvency
What probably matters more is the other, more technical-sounding things, that the Bank announced.
The Bank says in its press releases that its job in this crisis “is to help UK businesses and and households manage through an economic shock that could prove sharp and large, but should be temporary.” The key word there is ‘temporary’ – this stuff is designed to get us over a nasty blip. Maybe it will be, maybe it won’t be. But let’s take one thing at a time.
The issue with a nasty blip (if that’s what this is) is liquidity, not solvency. In other words, you can be running a perfectly viable cafe in a nice high street with lots of regular customers and no coffee chain shops nearby to spoil your fun.
But if people are stuck in their houses for fear of catching a bug, your cafe becomes temporarily unviable. No money comes in the door, you can’t pay your rent and your other bills, and your business shuts down.
Multiply that economy-wide, and everyone who is owed anything by businesses like yours starts to run into trouble too. You get a spiral of missed payments, bankruptcies, and job losses, all of which makes recovering from anything much, much harder.
What you ideally need is a circuit-breaker. You can’t make people go out to the cafe for a full English breakfast (or a lunchtime steak frites, if you prefer). So you need to stop the cafe owner from shutting down, and to do that you need to make sure they can get their hands on money (or that the people they owe money to have the leeway to be lenient with them).
The interest-rate cut is all about keeping cash flowing to businesses
It’s all about cash flow, or the absence of it.
So firstly, the Bank is introducing a new term funding scheme for small and medium sized enterprises (TFSME). What does that do? For the next year, high street banks will be able to borrow money from the Bank of England at near-enough 0.25% for a period of four years. Those that boost their lending to small businesses will get extra funding.
Put simply, the Bank is offering high street banks a reliable source of cheap funding which they can then lend out at slightly higher rates to small businesses. They make a profit, small firms get their working capital, and everybody’s happy.
Overall, the Bank reckons banks will take them up on more than £100bn of this. The idea is to “incentivise banks to provide credit to businesses and households to bridge through a period of economic disruption.”
Secondly, the Bank is easing its rules regarding the money that banks need to put aside when markets look frothy (this is known as the countercyclical capital buffer rate). The Bank argues that banks don’t need this extra capital right now because the coronavirus disruption should be temporary.
Again, this is just to encourage the banks to make sure they keep the taps open during the worst of this crisis. The Bank also notes that its various watchdogs “will monitor closely the response of the banks to these measures as well as the credit conditions faced by UK businesses and households more generally.”
They’ve also warned them not to raise dividends or bonuses in reaction to this. The fact that the Bank feels it has to say that speaks volumes, but the message is extremely clear here: “keep lending or else”.
Now, this is the banking sector’s opportunity to rehabilitate its reputation in the wake of 2008. My cynicism is such that I can’t be sure they’ll grab it with both hands – but equally, they’d be rather stupid not to take advantage of the potential good PR that can come from being genuinely helpful to businesses and individuals in trouble.
Now, all of this is based on the current view that this crisis is temporary. So we shut down for three months or whatever, and then we get back to work, it’ll help. If not, we’ll need to revisit the scene. But for now, let’s wait and see what the Budget has in store on top of all this.