Bank of England to UK bankers: Start lending

Mark Carney in London, Britain July 5, 2016.
Dylan Martinez | Reuters
Mark Carney in London, Britain July 5, 2016.

Britain's central bank Tuesday sent a clear message to the nation's cautious bankers. You need to start lending more money.

The move came as uncertainty over the recent Brexit referendum to leave the European Union threatens to send the U.K.'s already weak economy into reverse. Ahead of the vote, bankers were reluctant to lend, and foreign companies and investors held off on committing capital to U.K. projects until British voters had their say.

But now, the historic vote to sever political and economic ties with Europe has cast an even darker shadow of the island nation's economic and political future.

"Britain's economy was headed down the tubes as foreign inflows faltered even before the Brexit referendum," said Carl Weinberg, chief economist at High Frequency Economics. "Voting to leave Europe only added a new layer of uncertainty to an economy that was already faltering."

Even before the vote, the U.K. was close to slipping into another recession. Gross domestic product advanced by just four-tenths of a percent in the first quarter of this year, down from six-tenths of a percent in the fourth quarter of 2015. That's the slowest rate since the fourth quarter of 2012, according to the country's Office for National Statistics.

To head off another downturn, the Bank of England Tuesday lowered the amount of capital that banks are required to hold in reserve, freeing up an extra 150 billion pounds ($196 billion) for lending. The move is aimed at offsetting a cash shortage after British bank stocks have taken a beating, eroding the equity portion of their capital base

"Those U.K. households and businesses who want to seize viable opportunities … can be confident that they will be supported by the financial system," Bank of England Governor Mark Carney told reporters Tuesday.

Freeing up cash can't hurt, but it won't help overcome U.K. bankers' caution at lending money to businesses and households until the long-term impact of the Brexit vote becomes clearer. That could take a while.

And while severing ties to Europe may help Britons regain a sense of independence and better control over their nation's destiny, it will do little to help their economy, according to analysts.

The leave argument rested heavily on the notion that, once freed from an oppressive thicket of EU regulations spewed by Brussels bureaucrats, Britain's feeble economy would once again regain its glory as a fully independent world power.

But the vote has badly undermined confidence in the British economy.

The number of businesses that are pessimistic about the economy over the next 12 months jumped to 49 percent in the week following the referendum, up from 25 percent before the vote outcome, according to a survey released Tuesday by the Centre for Economics and Business Research. Expectations for sales, exports and investments over the next 12 months fell "off a cliff," the consulting firm said.

Even before the vote, business and investors had begun hunkering down. Foreign flows of capital into commercial real estate fell 50 percent in the first three months of 2016, and transactions fell further in the second quarter, according to the latest data from the Bank of England.

That caution was warranted, if the sharp drop in the British pound since the vote took place is any gauge. As the global financial markets continue to try to find a footing, currency traders continued to dump the U.K. currency. On Tuesday, sterling fell to another 31-year low against the dollar, extending losses to nearly 12 percent from levels before the Brexit results were announced.

Assurances from British government officials that the economy is sound, as well as central bank pledges to defend the currency, have done little to stem the slide.

"The U.K. has entered a period of acute and extraordinary uncertainty not seen since the Second World War," said analysts at IHS Global Insight in a note to clients. "The [country] currently does not have a political leadership or a cohesive government, let alone a plan with which to navigate a way forwards."

The cloud hanging over the crash in sterling, if the recent losses are sustained, could have one silver lining. A cheaper pound would make British exports more competitive in European markets and around the world, helping to narrow a widening trade deficit with Europe.

Whatever trade gains Britain sees from the export boost with a weaker currency, though, it will pay for in the form of higher-priced imports, which will now cost more when paid for with newly devalued pounds.

U.K. inflation is currently running at just 0.3 percent on an annual basis, which has given British central bankers plenty of leeway in holding interest rates at historically low levels, currently just half a percent. But if inflation rises, central bankers will have much less latitude in suppressing rates to stimulate the economy.