The Bank of England to print money for the U.K. government

The U.K. government’s overdraft extension at the Bank of England shows that the coronavirus pandemic will be so costly that even the country’s leadership is worrying about how to finance it.

As the U.K. unleashes the biggest fiscal stimulus in decades, the concern is that its borrowing strains the ability of debt markets to soak it up, pushing interest rates higher and burdening the economy even more. Now the government can bypass markets — at least temporarily — to cover the bill.

It’s a dramatic move for the government, and one that risks blurring the lines between monetary and fiscal policy — something that historical experience suggests can ignite inflation and undermine central-bank independence.

“What would be telling now is if it’s extended indefinitely,” said Neil Williams, senior economic adviser to Federated Hermes. That “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.”

The Treasury is keen to emphasize that’s not the case, saying the measure is temporary and any borrowing will be paid back quickly.

It certainly provides further evidence of the lockstep regime defining the U.K. response to the coronavirus crisis though, an approach that has become a model of policy coordination in the Group of Seven.

In an op-ed for the Financial Times on Sunday, BOE Governor Andrew Bailey rejected the idea of using monetary financing to help contain the economic impact of coronavirus, and said the bank’s policies stop short of such action.

On March 18, Bailey told journalists, “I don’t think at the moment we’re facing an inability of the government to fund themselves.”

Gilts were little changed after the announcement on Thursday. The overdraft isn’t related to the central bank’s quantitative easing program in which it buys bonds in the secondary market.

Highest premium in more than a decade points to an unwillingness by banks to lend

The government still intends to use markets as its primary source of funding and already doubled its planned gilt issuance this month.

The overdraft credit line normally amounts to about 400 million pounds ($500 million) but reached almost 20 billion pounds in the financial crisis. The government hasn’t drawn on the facility since then.

Borrowing directly from the BOE avoids adding pressure to short-term rates, which signal that lending between banks hasn’t been functioning properly. The difference between three-month sterling Libor and overnight swaps is the highest in more than a decade.

Most central banks around the world have cut rates to around or below zero, but fiscal stimulus packages vary. The U.S. is providing around 10% of gross domestic product in support, Germany about 4.5%, while Japan’s program is worth about 20% of GDP, according to Bloomberg Economics.

Britain needs to find an extra 130 billion pounds in the current fiscal year, according to the Institute for Fiscal Studies. That will take its total financing needs to over 290 billion pounds, or around 13% of economic output.

Wage Promise

Measures already announced include a package that pays 80% of furloughed workers’ wages and grants for small businesses.

The Treasury and the BOE have gone out of their way to portray a united and coordinated front in their actions to combat the economic fallout from the coronavirus. That was most evident when the central bank delivered an emergency interest-rate cut on March 11, designed to complement the Treasury’s stimulus budget presented just hours later.

Any drawings from the BOE overdraft will be repaid before the end of the year, the Treasury said. It declined to comment further.

“As long as the liquidity created by the central bank to finance the deficit is temporary, and withdrawn once the outbreak is over, the consequences for long-run inflation expectations should be limited,” Richard Hughes, an analyst at the London-based Resolution Foundation think tank and a former Treasury official, said on Twitter.

Source: Bloomberg