UK interest rates slashed to deal with coronavirus
Governments and central banks globally have taken drastic action to support economies following the spread of the novel coronavirus. Last week, the Bank of England launched significant action.
The novel coronavirus is spreading widely in Europe and America. Judging by what has happened in China and Italy, which have the most advanced problems, other countries will face rapid increases in cases.
Governments may impose more restrictions on travel and economic activity, or people may simply impose the restrictions on themselves. More people will work from home and self-isolate. More businesses will suffer major reductions in revenue in areas like tourism, travel, events, restaurants and hotels. Some companies will struggle to meet interest charges and repayments of their debts. In due course each country will reach peak infection and things will then gradually start to return to normal, as we are seeing in China where they claim the epidemic is subsiding.
In recent days the Federal Reserve in the US has announced a 0.5 of a percentage point cut in its official interest rate and has continued to supply substantial liquidity to markets. The President would like to cut payroll taxes and target financial aid to airlines and the cruise industry.
The Democrats favour targeted income support for people on low incomes, people facing temporary loss of employment and reimbursement for virus-related medical bills. It is not clear how this big political divergence will be tackled, but further measures are likely and wanted by most involved.
In the European Unions (EU), the Commission has granted Italy permission to spend and borrow more on virus-related temporary spending even though they are above the budget limits allowed. Christine Lagarde, the new head of the European Central Bank (ECB), is said to have warned the EU in stark ECB will beef up its response, though it is already buying bonds under a quantitative-easing programme and making cheap lines of 3-year credit available to commercial banks to encourage bank lending.
Britain cuts rates
This morning, the Bank of England unveiled a wide-ranging response to the situation. It too announced a 0.5 percentage point interest-rate cut. The Bank also cancelled its increase in the countercyclical buffers, a regulation which limits the amount banks can lend commercially. It proposes a £100bn Term Funding scheme for banks which are lending to small and medium-sized enterprises. These measures mean commercial banks have access to £190bn of permitted additional lending. Future lending can be financed by existing cash and reserves and by the Term Lending money available at 0.25% or thereabouts. The regulator has warned the banks not to use this cheap money to boost bonuses and dividends.
There is some two-way trade now in the markets after the big falls of recent days. Bulls point to the large new sums of money being made available to sustain businesses and asset values and to the fact that shares are a lot lower now.
Bears point to the worsening hit to the economies from the virus, which will bring down profits and dividends and lead to more financial stress in a range of companies. We fear there is still more bad news to come as we strive to see through the epidemic’s impact, with many commentators and forecasters who have been too optimistic, having still to revise their forecasts and estimates down. It looks too early to sound all-clear for the world economy and markets.
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John Redwood is Chief Global Strategist at Charles Stanley & Co. Limited, which is authorised and regulated by the Financial Conduct Authority.