Bank Demand at BOE Liquidity Operation Surges After Brexit

  • BOE allots 3.1 billion pounds; bids at highest since 2014
  • Mervyn King says central bank is right to provide funds

Banks’ demand for cash surged at the Bank of England’s first liquidity operation since the U.K. voted to leave the European Union, with financial institutions requesting more than double the amount allocated.

At the auction of cash in exchange for collateral, banks were allotted 3.1 billion pounds ($4.1 billion). They bid for 6.3 billion pounds, the highest since the central bank started its revamped repo operations in February 2014. The operation also saw the biggest allocation of money at the central bank’s lowest grade of acceptable collateral.

The indexed long-term repo operation, five days after Britain voted for Brexit, showed that banks mostly bid using so-called Level C collateral, the lowest quality that can be used for such auctions. It includes residential mortgage backed securities, covered bonds and asset-backed debt, and borrowers pay a premium when they use such collateral.

The BOE held four ITLRs this month instead of the usual one as part of plans to with any issues surrounding the referendum. The vote result last week sent the pound and stocks into a two-day slump, with banks among the hardest hit. Stocks gained on Tuesday, with the FTSE-350 Banks Index up 2.7 percent as of 12:40 p.m. London time.

‘Modest Stress’

“It’s becoming more competitive for liquidity and we can see that there are some modest signs of stress outside of the equity prices, where are there are much clearer signs of stress,” Philip Rush, an economist at Nomura International Plc, said in a telephone interview. “This is a higher call for liquidity than the banking system has asked for for a long time, but 3 billion pounds in the grand scheme of things is relatively low. It could have been a lot worse.”

The International Monetary Fund warned before the vote that Brexit could cause a potential credit squeeze if liquidity markets dry up, which could deter spending and investment. Carney pledged last week to provide as much as 250 billion pounds of funding to the financial system if needed.

Taking all four BOE auctions this month, June’s take-up from the BOE now amounts to about 9.2 billion pounds. The average for six-month operations between December 2015 and May 2016 was 3 billion pounds.

The clearing spread paid by banks on the Level C collateral was 20 basis points above the BOE’s benchmark interest rate of 0.5 percent at Tuesday’s operation. That compared with 15 basis points in all the previous auctions since the central bank widened the range of assets accepted in 2014.

The premium on bonds backed by prime U.K. mortgages rose to the highest above benchmark rates in almost four years after the EU vote, according to JPMorgan Chase & Co. The average additional yield demanded by investors increased 22 basis points to 75 basis points on Friday and remained close to that level on Tuesday, the data show.

“I think it’s a sign of caution, that people want to find themselves in a position where they know they will have access to liquidity, and to lock that it in in advance, so they can’t be caught out unexpectedly,” former BOE Governor Mervyn King said in a Bloomberg Television interview after the auction. “The bank has rightly provided that.”

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