BOE Lending-Plan Miss Opens Door for Carney Policy

Chancellor of the Exchequer George Osborne’s 10-month-old lending plan has disappointed some economists, opening the door for incoming Bank of England Governor Mark Carney to put his stamp on loan-creating policies.

Seven of 13 economists surveyed by Bloomberg News say the Funding for Lending Scheme hasn’t met their expectations, while Bank of Israel Governor Stanley Fischer and ex-BOE policy maker Adam Posen pointed to concerns on the plan today. While borrowing costs have dropped since Osborne and BOE Governor Mervyn King announced the program at their annual Mansion House speeches a year ago, credit is still shrinking.

This year’s Mansion House addresses take place on June 19, less than two years before Osborne faces a general election and 11 days before King retires. Carney has floated the idea of forward guidance on the bank’s benchmark interest rate, which may give households and companies the confidence to borrow.

“I never saw a big pickup in lending from the program, but I would have at least thought it would stem the fall in lending,” said Rob Wood, an economist at Berenberg Bank in London and a former central bank official. “It was a sensible thing to do and its helped households, but businesses still remain uncertain on the recovery and that’s the main problem still to solve.”

Shrinking Credit

Lending by the 40 banks participating in the FLS fell 300 million pounds in the first quarter after declining 2.4 billion pounds in the final three months of 2012, the central bank said last week. The stock of outstanding loans has shrunk 1.8 billion pounds since the end of June 2012.

Lending may have grown no more than 40 billion pounds ($63 billion) by the time the plan ends in January 2015, a separate survey shows.

The FLS “looked very good in design,” Fischer said at a conference organized by the Tel Aviv Stock Exchange held at Bloomberg LP’s London office today. “It seems to not have been working exactly as planned at the beginning. I know they are trying to get that fixed.”

The program “has been disappointing,” Posen told Francine Lacqua in an interview on “The Pulse” on Bloomberg Television today in London. Posen, now president of the Peter G. Peterson Institute for International Economics in Washington, said the initiative isn’t working because it relies on banks that are still “totally damaged.”

“You have to try to go around the banking system,” and the BOE should adopt a credit-easing policy that purchases assets other than gilts, he said.

Mixed Response

The response of the mortgage market to the FLS has been mixed. The average rate on a two-year fixed-rate mortgage was 2.87 percent in April, down from 3.74 percent in June last year, BOE data show. Rates on standard variable-rate loans rose to 4.35 percent from 4.16 percent.

Lenders approved 51,700 mortgages a month on average since June last year, about half the monthly average in the decade before the financial crisis struck in 2007, Bank of England data show. Since the start of 2012, lending to households rose, while loans to businesses fell, the bank said on June 3.

“We’re seeing a bit of a pickup in the mortgage market, but we’re still concerned about business lending,” said Katie Evans, an economist at the Centre for Economics and Business Research in London. “We could see another policy push.”

Funding Costs

Osborne and King unveiled the FLS amid evidence that the European debt crisis was undermining Britain’s economic recovery. The plan allows banks and mutual lenders to borrow Treasury bills from the Bank of England for as long as four years, providing them with collateral to raise wholesale funds at discounted rates.

The plan has helped bring down bank funding costs. Average senior unsecured bond rates for banks have fallen 1.4 percentage points since June 2012, the BOE said in its report on first-quarter usage of the FLS.

Under the proposal, a 5 percent increase in lending would inject about 80 billion pounds into the economy, though officials gave no targets. The FLS was extended by a year in April and expanded to target smaller firms.

The BOE said in a statement last week that net lending should become “modestly positive” this year, against a staff forecast before the FLS was launched for a decline. Credit has contracted partly because of a decline in lending to real estate companies.

Twelve out of 14 economists surveyed by Bloomberg agree with the bank and see a pickup in loans in 2013. Three bank analysts polled gave estimates ranging from 35 billion pounds to 40 billion pounds by January 2015, based on their models of the program’s effect.

‘Modest Recovery’

Since last year’s Mansion House speeches, strains in Europe have eased and the U.K. economy has avoided a triple-dip recession with expansion of 0.3 percent in the first quarter. King said last month that while a “modest recovery” is under way, “more needs to be done” to encourage growth.

“Things are improving but we’re not expecting a strong pickup by any means,” said Victoria Clarke, an economist at Investec Securities and a former Treasury official. “It will be difficult to be scratching around on new policy initiatives they could unveil. There’s no quick fix as this is tied into everything that’s holding back the recovery.”

One measure that may boost confidence and demand for credit is forward guidance, which Carney used as governor of Canada’s central bank. The BOE’s Monetary Policy Committee, which has kept the benchmark rate at a record-low 0.5 percent since March 2009, will give the Treasury its views on implementing such a policy by August.

Forward Guidance

“Announcing a date for interest rates to start rising will prevent any uptick in borrowing costs,” said Melanie Bowler, an economist at Moody’s in London. “That will make it much harder for U.K. lenders to justify raising interest rates.”

Another option for Carney, who takes over on July 1, is to make the Funding for Lending Scheme permanent, according to Chirantan Barua, a banking analyst at Bernstein Research in London.

“If policy makers are actually serious about opening up the space, they might actually do well to institutionalize Funding for Lending,” he wrote in a June 7 note. “It’s worth considering for the next BOE governor.”

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