UK (Sky News)

Markets don’t think UK is acting like Zimbabwe – but will need reassuring

By May 11, 2020 No Comments

It is a little-known fact that even the UK government has an overdraft facility.

It’s called the Ways and Means Facility and it resides at the Bank of England.

Ordinarily, the government would finance its borrowings either by selling gilts – UK government IOUs – or by raising money from savers via National Savings & Investments.

Anyone who buys a premium bond is, effectively, loaning money to the government.

However, there are times when the government needs to bypass the sterling money markets or gilt markets, as is the case at present.

Accordingly, the Treasury and the Bank of England announced today that if necessary, the facility would be extended.

Typically, the facility stands at £370m, as it has since April 2009.

It can, though, be increased rapidly should the government need cash urgently on a short-term basis to meet its outgoings.

At the height of the financial crisis, from the end of December 2008 to February 2009, it shot up to £19.9bn.

Disclosure today that the facility could be extended, if necessary, has raised eyebrows because the Bank of England is owned by the government.

It will raise concerns that the Bank of England is engaging in so-called “debt monetisation” or “monetary financing”, in other words, effectively printing money to pay the government’s debts.

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This is something that is synonymous with the hyper-inflation suffered by Germany during the 1920s or, more recently, in Zimbabwe.

The move has also caused surprise in some quarters because the new governor of the Bank, Andrew Bailey, said only last month in a phone call with reporters that the facility was just a “historical feature”.

He followed that up with an article for the Financial Times, earlier this week, in which he was at pains to stress that the Bank was not engaging in ‘monetary financing’.

He wrote: “Using monetary financing would damage credibility on controlling inflation by eroding operational independence.

“It would also ultimately result in an unsustainable central bank balance sheet and is incompatible with the pursuit of an inflation target by an independent central bank.

“But the UK’s institutional safeguards rule out this approach.”

So does today’s news represent a u-turn?

Has the chancellor, Rishi Sunak, suddenly turned into Robert Mugabe?

The answer is no.

If markets thought otherwise, news that the facility may be extended would have been greeted by a big sell-off in the pound, which instead remained more or less unchanged.

The lack of panic is because both the Treasury and the Bank have stressed today that the move is merely a short-term expedient – a way around the fact that, during the next few weeks, the government’s spending requirements may become so great that it would not be possible to raise the sums it needs via the gilt and sterling money markets without causing disruption to them.

This measure will prevent any instability.

As Allan Monks, economist at JP Morgan Securities, put it: “The Ways and Means facility extension will almost certainly be temporary – it is essentially dealing with a bottleneck in the gilt market – and so it is hard to view this facility as doing anything other than ensuring that the government is able to deliver the emergency support it has promised in the most timely and cost effective way.”

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John Wraith, strategist at UBS, pointed out that the Bank and the Treasury had stressed that any drawings under the facility would be repaid as soon as possible before the end of the year.

He added: “The announcement comes against the backdrop of the government’s Covid-19 fiscal package, which is adding up to at least £70bn (3.2% of GDP) and likely significantly more when taking into account the cost of the job schemes, which we think could cost around 1.5-2.4% of GDP.

“Raising such a large amount of money in a very short timeframe through the usual gilt market route would have risked market disruption, spikes higher in yield and possibly uncovered auctions [where investors fail to buy gilts being sold by the UK’s Debt Management Office] if the DMO had tried to supply more debt than the market could readily absorb.”

However, investors will need constant reassurance that the facility is only being expanded on a very temporary basis, rather than representing a permanent rise in borrowing.

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Moyeen Islam, economist at Barclays investment bank, said: “Recent experience tells us that what is temporary can often become permanent and expand – we need only to look at [the Bank’s] asset purchase [scheme] to see this.”

And Neil Williams, senior economic adviser to the international business of fund manager Federated Hermes, added: “The overdraft extension is only to be expected in the current environment, given that there is limited monetary ammunition left, the UK’s fiscal gun is now firmly on, and this tool has been used as a last resort in the past, as we saw in 2008.

“What would be telling now, is if it’s extended indefinitely, which might further blur the operational distinction between the fiscal and monetary authorities, a demarcation that may inevitably be brought into question as gilt issuance escalates and QE moves toward infinity and beyond.”

Another key point to make, as Mr Bailey stressed in his FT article this week, is that the Monetary Policy Committee “remains in full control” of the Bank’s balance sheet.

It means that, if the MPC becomes concerned that another emergency measure, the Bank’s asset purchase scheme (quantitative easing in the jargon), threatens its ability to hit its inflation target, it can unwind the scheme.

So savers, investors and businesses can relax for now.

On this evidence, the UK is not about to turn into Weimar Germany.

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