October 5, 2011 / 3:39 PM / 9 years ago

UK credit easing no cure for QE's limits

LONDON (Reuters) - British government plans for some form of ‘credit easing’ to channel loans directly to businesses could tackle one major shortfall in the Bank of England’s quantitative easing policy, but may be too little, too late to really lift growth.

A woman passes a window advertisement showing a one pence coin in west London September 9, 2010. REUTERS/Toby Melville

The Bank looks increasingly likely to launch a second round of asset purchases funded by newly printed money either this month or next, due to the vulnerability of Britain’s tepid economic recovery to spillover from the euro zone debt crisis.

On paper, credit easing looks the perfect complement. While the past round of QE between March 2009 and February 2010 helped bring down British government bond yields, any effect in boosting the trickle of bank lending to smaller firms and households is much harder to see.

“Buying government bonds is pretty unimaginative,” said Alan Clarke, an economist at Scotia Capital. “What we really want to do is simulate the effect of an old-fashioned interest rate cut ... which would reduce costs for all borrowers.”

The Bank bought 200 billion pounds of bonds first time around, helping borrowing costs as measured by government bond yields to drop by around 100 basis points. It is expected to kick off another 50 billion pounds injection on Thursday, or next month.

With gilt yields already at record lows, it is hard to see much impact on the real economy even if more QE succeeds in pushing them a little lower still. Meanwhile, smaller businesses complain they are starved of credit, whatever its cost.

Under plans trailed by Chancellor George Osborne at his Conservative Party’s annual conference on Monday, the government is considering buying billions of pounds of corporate bonds, funded by the issuance of short-term debt.

Other options that might come into play include proposals — similar to those suggested by BoE policymaker Adam Posen at the start of the month — for the government bond-buying agency to buy up bundles of loans to businesses too small to issue hundreds of millions of pounds of corporate bonds on their own.

With luck, this second approach may catalyse the development of a corporate funding market that is surprisingly small in Britain compared to other advanced economies.

However, economists are sceptical about how big a boost this credit easing is likely to provide to Britain’s economy, first because of doubts about the practicality of the scheme, and second due to questions about firms’ true demand for credit.

If the government goes down the route of buying corporate bonds, it has to contend with the fact that the Bank of England already tried this as part of its QE scheme, but struggled to buy just 1.5 billion pounds of corporate bonds, compared to nearly 200 billion pounds of gilts.

The government may be able to buy lower grade bonds than the Bank did, and offer keener prices, but this will increase the risk to taxpayers, and the overall sums are still small.

“It’ll be a challenge to spend tens of billions. The Bank certainly found that the case,” said George Buckley, an economist at Deutsche Bank. “And QE2 will blow this plan out of the water in terms of the scale of it.”

Moreover, the kind of firms that are able to benefit from lower interest rate costs on the corporate bond markets are typically very large companies that already have the least difficulty in raising finance.


This is where the second scheme potentially being considered by the Treasury comes in. A new government agency would attempt to kick-start a market in packages of loans to small companies that currently are wholly reliant on banks for debt financing.

Ironically, the structures would be similar to the tradeable bundles of residential mortgages which triggered the financial crisis.

As a result, setting up similar packages of loans to companies is likely to be complex and relatively costly due to the amount of due diligence needed.

“It becomes enormously difficult when you’re trying to pool loans to SMEs compared to plain vanilla mortgages. There are lots of obstacles, although I don’t think they’re insurmountable,” said Philip Shaw, an economist at Investec.

A deeper question is the extent to which the slow growth in lending and business investment in Britain since the financial crisis is due to firms’ lack of confidence about demand for their products, rather than the simple cost of borrowing.

Business surveys do not give a clear answer. A report published last week by accountants BDO and an association of small-cap listed companies described the firms as “hamstrung” by illiquid capital markets.

By contrast, a survey sponsored by the British Bankers’ Association — whose members are frequently criticised for stymieing the recovery — implied that only 2 percent of small firms said the cost of credit was what stopped them borrowing. Economic uncertainty was a far bigger factor.

“At the margins credit easing may be helpful. But do businesses want to borrow when the risk in wider economy is of recession,” queried Scotia Capital’s Clarke. “Just grin and bear it, and accept that we are going to be growing more slowly.”

Reporting by David Milliken, editing by Mike Peacock

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