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From 1 July 2017, the finance and banking industry operating in the UK will be represented by a new trade association, UK Finance. It will represent around 300 firms in the UK providing credit, banking, markets and payment-related services. The new organisation will take on most of the activities previously carried out by the Asset Based Finance Association, the British Bankers’ Association, the Council of Mortgage Lenders, Financial Fraud Action UK, Payments UK and the UK Cards Association.x
Written by Rebecca Harding, Chief Economist
In the weeks since the EU referendum vote, the Bank of England has shown itself to have both a contingency plan to avoid a financial crisis and a strong commitment to shoring up the lending base of the UK economy. Last week’s Financial Stability Report anticipated a drop in demand for borrowing by providing £5.7bn of new lending facilities in the form of reduced counter-cyclical capital buffers and reduced the capital requirements for banks to support an additional £150bn in bank lending to households and businesses.
As the Monetary Policy Committee gathers this week to make its interest rate decision, it would do well to consider the challenges faced by banks when lending to household and businesses. There is little evidence of a link between lower interest rates and higher lending, either to businesses or to households. Figure 1, shows that, despite persistently low interest rates in the post-crisis era, lending to business has not grown substantially beyond its pre-crisis levels in January 2007.
Source: BBA statistics
Further, as Figure 2 shows, there is already evidence that households are using short-term borrowing rather than longer-term lending facilities such as mortgages. Indeed, paradoxically perhaps, individuals and businesses are simultaneously building up deposits suggesting an underlying nervousness about the economy.
Source: BBA statistics
Alongside the liquidity measures that are currently being undertaken to maintain stability the Bank of England is providing liquidity but, in this instance at least, it may well be that supply of finance does not create its own demand; it is necessary, but not alone sufficient. The problem for the MPC is this: lower rates may yet encourage further borrowing. But this is only likely to be at the margin – any increase in loan applications is likely to be small and therefore have little impact on the push to avoid broader recessionary pressures.
More than this, the other data published this week should also give the MPC pause for thought as it will give a broader indication of the underlying pressures in the economy, albeit on the basis of pre-Brexit data. The Federation of Small Business confidence survey published last week suggested that 58.2% of businesses felt that the domestic economy could be a barrier to their growth this year. It follows that this nervousness around investment may be evident in the Markit Economics business outlook survey; the BBA’s own SME lending data could suggest pressures in this sector as well.
In addition, construction output data is not expected to be strong given that lending has fallen back to construction companies over the past few months. Since the construction sector is something of a bellwether for the UK economy linked, as it is to the housing and commercial property markets as well. The immediate aftermath of the Brexit vote has been a sharp drop in the share prices of property companies and asset managers and financial institutions with strong property portfolios. The UK Construction PMI fell substantially to 46.0 this month so it is unlikely that construction output will surprise to the upside.
Source: Bank of England data, ONS
Source: BBA statistics, Markit
All of this will mean that the MPC should consider its options carefully when it meets this week. There are obvious reasons to lower rates quickly and create a clear signal to markets that the Bank of England will, indeed, do “whatever it takes” to limit the effects of what already appear to suggest recessionary pressures ahead.
A swift reaction like this may nevertheless be limited in its effect. It will take a while for the full effects of the Brexit decision to work through financial markets; we are still not seeing “post vote” data. Lower rates are unlikely substantially to increase lending; the immediate effect on the economy is also likely to be limited as a result. The MPC may well do best to consider waiting until there is more evidence of the economic and financial impact of the UK Referendum’s outcome before acting on interest rates.