Chancellor of the Exchequer Rishi Sunak is poised to increase emergency borrowing from an overdraft at the Bank of England to keep injecting fiscal aid to the economy while staving off immediate pressure to sell bonds.
With Britain still afflicted by a freeze in activity due to the coronavirus crisis, the Treasury said it’s increasing the BoE’s Ways and Means facility by an unspecified amount.
That’s a short-term credit line to smooth cash flow and support functioning of markets. It normally amounts to about £400mn ($500mn) but reached almost £20bn in the financial crisis.
“In the interim, this was needed,” said Sanjay Raja, a UK economist at Deutsche Bank AG in London. “It will be important to see if this just an emergency stop-gap for the Treasury or rather a more fundamental regime shift.”
The move provides further evidence of the lockstep regime defining the UK monetary and fiscal response to the coronavirus crisis, an approach that has become a model of policy co-ordination in the Group of Seven.
Officials insist that the use of the overdraft arrangement is temporary and shouldn’t stoke fears, based on historical experience, that such ties could ignite inflation and undermine central-bank independence.
In an op-ed for the Financial Times on Sunday, BoE governor Andrew Bailey rejected the idea of using monetary financing to help contain the economic impact of coronavirus, and said the bank’s policies stop short of such action.
On March 18, Bailey told journalists, “I don’t think at the moment we’re facing an inability of the government to fund themselves.”
Gilts were little changed after the announcement. The government still intends to use markets as their primary source of funding and the UK has already doubled bond sales this month to help fight the crisis.
The government already doubled its planned gilt issuance this month to £45bn, and while the funds raised may be funneled back into the economy quickly, it may give banks more reason to hoard cash at a time to when corporates need it most. So if the Treasury needs more funds, tapping the short-term facility would keep the transaction out of financial markets.
It would also avoid adding pressure to short-term rates, which signal that lending between banks hasn’t been functioning properly. The difference between three-month sterling Libor and overnight swaps is the highest in more than a decade.
Most central banks around the world have cut rates to around or below zero, but fiscal stimulus packages vary. The US is providing around 10% of gross domestic product in support, Germany about 4.5%, while Japan’s program is worth about 20% of GDP, according to Bloomberg Economics.
Britain needs to find an extra 130bn pounds in the current fiscal year because of the heavy cost of its rescue efforts and the blow to tax revenue from the economic downturn, according to the Institute for Fiscal Studies. That will take its total financing needs to over 290bn pounds, or around 13% of economic output.
Measures already announced include a package that pays 80% of furloughed workers’ wages and grants for small businesses.
The Treasury and the BoE have gone out of their way to portray a united and coordinated front in their actions to combat the economic fallout from the coronavirus. That was most evident when the central bank delivered an emergency interest-rate cut on March 11, designed to complement Sunak’s stimulus budget presented just hours later.
Any drawings from the BoE overdraft will be repaid as soon as possible and before the end of the year, the Treasury said. It declined to comment further.
“As long as the liquidity created by the central bank to finance the deficit is temporary, and withdrawn once the outbreak is over, the consequences for long-run inflation expectations should be limited,” Richard Hughes, an analyst at the London-based Resolution Foundation think tank and a former Treasury official, said on Twitter.
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