Did the UK Just Bail Out the Banks Again?

Do you remember that old Franco Cozzo furniture ad from the 80s? The Furniture doyenne from ‘Footisgray’ became an Aussie cultural icon. Thanks to his unique ‘DIY’ TV ads for his furniture store, Cozzo became a household name.

Walk up to any Aussie (over 30) in the street and say ‘Gran Sale, Gran Sale! In Brunaswick and Footisgray! Migalo, migalo, migalo.’ They’ll know exactly who you’re talking about.

As I was watching Bank of England Governor, Mark Carney talking about the British economy today, I couldn’t help think of Franco Cozzo.

Where Cozzo was a furniture salesman extraordinaire, it felt like Carney was trying to do the same thing. Except rather than sell furniture, he was trying to sell his new stimulus package.

I swear I could almost hear him murmur under his breath, ‘Gran Sale, Gran Sale…

Eliminate uncertainty? I don’t think so Mark

On Thursday Carney, and the monetary policy commission (MPC), decided to cut the Bank of England cash rate. They lopped 0.25% off the current rate of 0.50%.

Sounds like finance in the UK is on a ‘Gran Sale, Gran Sale’

Now the rate cut wasn’t a surprise. In fact it had been an almost certainty since the Brexit. Remember that the decision to leave Europe only fell around six weeks ago.

That’s significant. Why? Well the decision to cut rates is effectively based on six weeks of economic data. Now answer me this, when has any monetary policy decision been based on just six weeks of data?

It hasn’t. The decision to cut rates by the MPC was part pre-emptive strike, part guess. That’s right, cutting rates now was in fact a guess as to what’s coming for the UK.

Carney himself said in a speech today that growth could be a little higher or could be a little lower than central estimates. That’s a fence-sit if I’ve ever heard one. However, as I said, the rate cut wasn’t unexpected. The fact is the UK economy has been in struggle town since well before the decision to leave the EU.

But now they have decided to leave there’s an inflow of uncertainty that the markets don’t like. Again, Carney said this cut, and the stimulus package involved, is intended to eliminate uncertainty.

Well good luck with that one. If there’s one thing you can’t eliminate in this market, its uncertainty.

For instance new PM Theresa May decided to put the kibosh on a brand new US$24 billion Chinese-French-British nuclear plant. On the day of the contract signings, the UK stalled. Do you think this impressed the Chinese?

Speaking to the Sunday Telegraph, Liberal Democrat former Business Secretary, Vince Cable said,

My recollection was that when approval was sought for Hinkley, she raised objections on the grounds of national security issues with China. She has expressed, in several different contexts, severe reservations about China getting too close to the UK.’

You’d think the UK would be bending over backwards to create strong ties with international trading partners. Apparently not.

Just when the BoE’s MPC says it’s eliminating uncertainty, uncertainty is stronger than ever.

Bank lending 101

Of course another part of the MPC decision was to pump ‘electronic cash’ into the economy to buy more government bonds. This extra £60bn takes UK quantitative easing to £435bn now. That’s a lot of money for an economy that still isn’t stimulated…

But even this wasn’t the surprising part.

The MPC decided to create a new ‘term funding scheme’ (TFS) for the banks. In other words, more money for the banks to help maintain margins and keep them profitable.

Erm, that sounds a bit like a bailout to me.

The TFS is £100bn that the MPC is holding aside to help out the banks. When rates are cut to near zero this creates a bit of a problem for your typical lending institution.

You see a bank is a company. That means their primary function is…to make profits.

Aha! You thought it was to provide banking services didn’t you?

It’s not. Their job is to make profits and provide return on equity to stakeholders. It just so happens they do this by providing financial services.

One of the biggest ways they make money is via lending. In other words they make profit margins on their loan products. The aim is to make more on the interest they charge you than it costs for them to borrow the money from other banks.

Now ‘interbank’ lending starts to get pretty complicated. But just think of it as the banks lending to each other so that your bank has enough to loan to you.

The problem is when the rates that you and I pay barely cover what it costs the banks. That’s called ‘margin squeeze’. You hear it bandied about a fair bit in low rate economies.

Banks don’t like margin squeeze. It means falling profits. And falling profits mean falling share prices. It’s all bad news for a bank really.

Look at it for what it is, a bailout

That’s why, when the Reserve Bank of Australia cut rates this week, the banks didn’t pass on the full rate cut. They couldn’t stomach falling margins.

If the RBA cuts again, don’t expect the banks to pass it on at all. In fact they might even increase rates if the RBA cuts again. Remember, they’re just a humble business trying to make a dollar…

Imagine that? Rising retail interest rates while the cash rate is falling.

This is a real possibility in a low rate environment. And it’s a huge risk facing the UK. That’s why the MPC decided to implement the TFS.

As Carney explained on Thursday, it’s money so that all the banks in the UK can pass on this rate cut in full. Without the TFS, it’s unlikely they’d budge retail rates at all. And when you’re trying to stimulate the economy and encourage lending, but retail rates that householders get don’t move or increase — well, it tends to stimulate sweet nothing.

What the MPC has done here is give the banks a helping hand. They’ve given them a quasi bailout. They’ve helped them keep their margins, and gone some way to keeping them from falling profits, falling share prices…from all out failure.

Sounds like a good idea. Except when you look at it for what it is, a bailout. Without that money the banks don’t cut their rates. The economy stagnates further. The MPC loses their effectiveness. It all leads to bad news.

It still might all lead to bad news. Carney made a point to say the TFS has enough in it for another rate cut if the MPC deems necessary. That would put the BoE cash rate at zero.

And if you think Australia is still some way away from this, think again. We’re on the same trajectory as the UK. A downward spiral towards zero — and then negative — rates.


Sam Volkering,
Editor, Money Morning

Sam Volkering is an Editor for Money Morning and is small-cap, cryptocurrency and technology expert.

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