Carney’s Brexit Warnings Ring True as BOE Meets on Stability

BOE Allots More Liquidity to Brexit-Battered Banks
  • BOE panel meets as bank demand for liquidity surges after vote
  • Pound and stocks see losses; U.K. credit rating downgraded

Mark Carney’s warnings that Brexit could inflict a fresh crisis on the U.K.’s banking sector may be coming to pass, and it’s up to him to try to stop it.

As the Bank of England governor chairs a meeting of financial-stability officials on Tuesday, the industry they oversee has been battered by investors. Britain’s vote to leave the European Union has ripped through markets, with U.K. bank stocks suffering their biggest two-day decline in seven years before clawing back some of their losses Tuesday.

Carney cautioned months ago that the referendum was the “biggest domestic risk to financial stability” and said in May that a Brexit vote could lead to a recession, comments that proved controversial in a vitriolic political battle. The remarks also signaled he wasn’t taking any chances with the BOE’s planned defenses against a referendum fallout.

One of those emergency measures was tapped on Tuesday, when the BOE offered funds in exchange for collateral at an extra auction, giving banks a chance to grab cheap cash for a fourth time this month, instead of the usual single operation. The central bank allotted 3.1 billion pounds ($4.1 billion) after banks sought 6.3 billion pounds, reflecting heightened economic and political insecurities and eroded confidence in lenders following the referendum result. Banks sought just 370 million pounds in the last operation before the vote.

Market Rebound

Markets rebounded from the Brexit rout on Tuesday, with bank stocks rising 3.3 percent as of 11:11 a.m. London time. The pound was trading at $1.3345, up 0.9 percent on the day.

“Carney needs to make sure markets carry on functioning effectively at a time when political chaos has the capacity to shock investor confidence,” said Ian Gordon, an analyst at Investec Plc in London. “Liquidity is not the biggest concern for U.K. banks these days, but additional drawing rights provide a further level of reassurance. Even though it may not be used in huge volumes, it doesn’t mean it isn’t sensible.”

In addition to special auctions, Carney was quick to respond to the referendum result last Friday, declaring that the central bank is ready to make 250 billion pounds available to the financial system. It also has swap lines to lend in foreign currency if required.

‘Right Things’

“So far, Carney has said what you’d hope to hear from him -- all the right things about detailed preparations, backstops and extra liquidity,” Gordon said. “In fact, he’s given all the sorts of reassurances Mervyn King needed to do back in 2007 when the banks were in a far worse situation” in the midst of the financial crisis.

On Monday, Chancellor of the Exchequer George Osborne added his voice to soothe investors and the public, saying that banks’ capital requirements are “10 times what they were” before.

“Unlike eight years ago, Britain’s financial system will help our country deal with any shocks and dampen them -- not contribute to those shocks or make them worse,” he said.

Still, the political uncertainty is casting a shadow, with S&P Global Ratings citing it as a risk when it cut the U.K. by two notches to AA on Monday. Conservative Prime Minister David Cameron announced his resignation last week and his opposite number, Jeremy Corbyn, is under pressure from his own Labour Party lawmakers to resign.

Bank Stocks

Barclays Plc and Royal Bank of Scotland Group Plc have felt the brunt of the selloff, losing more than a quarter since the “out” vote. Trading was halted in both stocks on Monday. Lloyds Banking Group Plc, which was bailed out along with RBS during the 2008 crisis, recorded almost its entire 25 percent year-to-date decline in the past two trading days. The pound hit a 31-year low on Monday, and many economists forecast the economy will slide into a Brexit-induced contraction.

The turmoil, and its potential impact on banking stability, is likely to dominate the meeting of the Financial Policy Committee, an 11-person panel set up after the financial crisis as part of an overhaul of oversight. Officials usually release a statement in the days after their gatherings, and are scheduled to do so along with the BOE’s latest bi-annual Financial Stability Report on July 5.

Market Actor

“The focus is more on the Bank of England because they’re the actor in the markets who can perhaps do more,” said Andrew Sentance, senior economic adviser at PricewaterhouseCoopers LLP and a former BOE policy maker. “In terms of the situation facing the banks, they’ve got to be prepared to provide liquidity if needed.”

The committee said in March that “heightened and prolonged uncertainty” could increase investors’ risk pricing of assets and “affect the cost and availability of financing for a broad range of U.K. borrowers.” The International Monetary Fund has since warned that Brexit could cause a potential credit squeeze if liquidity markets dry up, which could deter spending and investment.

Compounding all that, uncertainty surrounding the U.K. and its new relationship with the EU will undermine confidence and deter investment. Goldman Sachs Group Inc. sees the economy slipping into a recession by early 2017, which could reduce consumer spending and demand for mortgages and car loans.

“I think it’s very probable now that the U.K. is going to head to recession,” said Danny Blanchflower, a former Monetary Policy Committee member who is now at Dartmouth College in the U.S. “It’s the classic Keynes animal spirits. If the people think it’s going to go down, it’s going to go down.”

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