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"An ugly picture"
Amid fears that the deteriorating situation in the eurozone could lead to another damaging credit crisis, the Bank of England (BoE) has announced new action designed to safeguard the UK financial system.
The measures – announced at the annual Mansion House dinner – are aimed at protecting the UK banking sector whilst tackling the increasing cost of mortgages and loans. They reflect escalating concerns over the possible effects of the eurozone’s debt crisis: according to BoE Governor Sir Mervyn King, the measures were initiated as a result of the deteriorating economic backdrop. The sovereign debt crisis in the eurozone has fuelled bank funding costs, increasing the cost of borrowing for UK businesses and individuals.
The BoE has opted for a different method of stimulus from the quantitative easing measures that policymakers have previously employed. Under the new “Funding for Lending” programme, the BoE will provide cheap loans to banks, which are intended to tackle the increasing cost of mortgages and loans. Rates will be low and will be linked to the banks’ performance in maintaining or increasing lending to non-financial UK companies. The BoE also announced the activation of the Extended Collateral Term Repo Facility, which will provide short-term funds to banks to allow them to redress any shortfalls in liquidity. Sir Mervyn described the measures as “a temporary bank funding scheme to bridge to calmer times”
Chancellor of the Exchequer George Osborne warned that a shortage of credit is damaging businesses and costing jobs. He believes the measures will “support the flow of credit to where it is needed in the real economy”, but warned, “Things could still get worse before they get better”.
In response to the announcement, the Confederation of British Industry (CBI) described the BoE’s plans as “a sensible pre-emptive move” but warned that the “Funding for Lending” scheme will need to be “practical for banks to participate... and, most importantly... easily accessible for small and medium-sized businesses.”
The BoE’s view of the economy appears to have deteriorated over recent months. The UK has fallen back into recession and the euro debt crisis has created “a large black cloud of uncertainty”. Meanwhile, further afield, there are signs of slowing in activity in “previously buoyant” emerging economies such as China, India and Brazil. Above all, UK policymakers appear anxious to ensure that the UK economy is not hindered in recovery by further turbulence in the eurozone.
Paul Dixon FPFS
Chartered Financial Planner