THE Bank of England’s (BoE) decision to extend its money supply-boosting programme of asset purchases – quantitative easing (QE) – by £25bn neatly bisected the expectations of those who thought they might discontinue it and those who thought they should do more.
The economy appears to be inching towards a recovery – favouring a “wait and see” approach – but the banking system remains less willing than before to finance new lending.
The latest £25bn to be implemented over three months is the second step down in the monthly rate.
The first £125bn was injected at a rate of £25bn per month from March to July, while the next £50bn was injected over the past three months, at £17bn per month.
So, it is tempting to conclude that with the latest rate being just over £8bn per month the QE policy is winding down. However, this is heavily contingent on whether an economic recovery becomes established and whether, when it does, the banks become more able and willing to lend.
The cyclical fears holding back banks’ willingness to lend may be fading but they are being pulled the other way by the longer-term pressure to reduce leverage and boost their capital ratios.
It will be a good thing if the BoE does not have to extend the programme at the time of its next inflation report in February as it would signify both a recovery and a healed banking system. But, if doubts remain, it is very possible the QE programme will continue.
Although the government has had to inject additional funds into Royal Bank of Scotland (RBS) and, as a 43% shareholder, take its share of the capital raising by Lloyds Banking Group, this does not mean that the bank rescue operation set in train in October 2008 has become a black hole for all the nation’s resources.
The reasons that both banks are raising additional equity are broadly to reduce the degree of leverage in their pre-credit crunch balance sheets – especially so for RBS – and to enable Lloyds to step away from the Asset Protection Scheme announced in the troubled environment of last March which had placed the taxpayer in line to pick up any excess losses on some of its riskier loan securities.
With the economy having improved, Lloyds has been able to convince its investors, including the Government, that it can stand on its own and avoid the costs of the state insurance scheme, as long as investors stump up £13.5bn more equity.
The fact that the markets have been willing to underwrite such a large capital raising is both a vote of confidence in Lloyds individually and a measure of how far confidence has improved.
If the economy continues to improve then the banks are likely to become more positive about their existing borrowers’ ability to repay their loans, making them more willing to make new loans.
If 2008 was the descent into the abyss and 2009 a period of convalescence, 2010 will be the test of when the banks can resume their normal role as willing lenders on sensible terms to creditworthy borrowers without further help from the BoE and the taxpayer.
Andrew Bell
Head of Research
Rensburg Sheppards
