LONDON: The Bank of England’s first rate cut since 2009 looks unlikely to be passed in full to borrowers, despite the BoE being ready to lend banks as much as 100 billion pounds to ensure it happens.
The launch of the Term Funding Scheme (TFS) – the BoE’s biggest intervention in Britain’s banking market in four years – is likely to offer a modest boost to growth. But it also highlights the difficulty of implementing cuts in interest rates as they approach zero.
Governor Mark Carney said lenders had “no excuse” not to pass on August’s quarter-point cut in interest rates to 0.25 percent, as the TFS would neutralise the negative impact of the rate cut on bank profits by providing lenders with cheap loans.
But less than a week later, things already look more complicated for the project that is part of the central bank’s response to Britain’s vote to quit the European Union.
Britain’s biggest mortgage lender, Lloyds Banking Group, is holding off cutting its main rate, while First Direct, part of HSBC, reduced the interest rate it pays out on one of its savings accounts by 0.4 percentage points.
“The narrative presented was a bit simplistic,” said Ian Gordon, a banking analyst at Investec.
The key point is that British lenders vary greatly in how much they can benefit from the TFS, depending on whether they already have access to finance that costs them less than the 0.25 percent minimum charge for funding from the BoE scheme.
Major lenders such as Royal Bank of Scotland, Barclays and HSBC already have more cash than they have been able to lend out, often from business and personal current accounts on which the banks pay little or no interest.
For them, the TFS will do nothing to reduce the squeeze on their net interest margin – the difference between savings and lending rates that is the main source of profit from lending.
As a result, interest rates on new two-year fixed-rate mortgages Britain’s most popular type of home finance – were likely to drop by less than 25 basis points, Gordon said, as banks’ sought to preserve profits and priced in a higher risk of default as the economic outlook darkened.
“I think prices will come down, but I’m sceptical you will see them come 25 basis points lower,” Investec’s Gordon said.
Existing mortgage rates that tracked Bank Rate would fall, but credit card rates and new business lending – which is sensitive to the economic outlook – would prove stickier.
Bankers say Lloyds and smaller challenger banks such as Virgin Money, Shawbrook and Aldermore gain more from the scheme, as they rely on costlier wholesale finance and savings accounts.
Gordon said this gave them scope to cut the interest they paid savers by more than a quarter percentage point – an effect of the TFS which the BoE has not chosen to stress.
None of this means the TFS is a waste of time, but it is unlikely to have the same impact as the BoE’s last big intervention, the Funding for Lending Scheme in 2012.
“Overall I think it will provide a small stimulus to the economy … but it’s not a game-changer,” Pantheon Macroeconomics’ Samuel Tombs said.
The FLS came at a time when British banks faced high borrowing costs due to the euro zone crisis, and offered incentives to lend as the economy gathered steam.
In just over a year, it provided more than 40 billion pounds of finance to banks and building societies.
By contrast, the TFS comes at a time when banks can already raise finance cheaply, and the BoE expects business and housing investment to fall sharply, reducing demand for loans.
“We are in a different world now where banks are in a much healthier position, where it’s not really the supply of credit that is the constraint on the economy,” BoE Deputy Governor Ben Broadbent told Reuters on Friday.
“There is no point in offering very powerful incentives to lend … because it is not clear they would be taken up.”
The roughly 100 billion pounds of newly created money available via the TFS represents about 5 percent of outstanding UK loans, and a fair chunk may be taken up by banks refinancing old FLS borrowing for another four years at a cheaper rate.
Full pass through of last week’s rate cut would take time, Broadbent said, and the BoE was not looking to police every single loan rate and would rely instead on competitive pressure to push down borrowing costs.
J.P. Morgan economist Allan Monks speculated that the TFS could ultimately provide a path for the BoE to introduce negative interest rates by the back door, circumventing Carney’s opposition and effectively paying banks to lend.
Broadbent, however, was quick to dismiss this. A European Central Bank scheme similar to the TFS, TLTRO II, showed the difficulty of getting banks to offer deposits or lend at negative rates, he said