By Svenja O’Donnell and Jennifer Ryan - Oct 7, 2011 6:07 PM GMT+0700
Bank of England Governor Mervyn King has lost faith in European governments’ ability to resolve the region’s debt crisis.
The central bank yesterday announced its biggest stimulus since the depths of the recession, citing “vulnerabilities” related to the euro-area turmoil. King said the move, the first loosening of U.K. monetary policy since 2009, was a response to what may be the worst financial crisis ever.
“It’s pretty much a vote of no confidence in European officials,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc and a former Bank of England official. “Either the virus is already in the U.K. so they had to respond, or they don’t believe the problem will be sorted out. I lean toward the second because of how much they’ve done.”
King’s refusal to wait for European governments signals determination to shield the U.K. from a crisis that threatens to tip Britain’s biggest trading partner into recession. It also shows concern that failure to protect bank funding markets risks recreating conditions that led to the collapse of Lehman Brothers Holdings Inc. three years ago.
The pound rose 0.6 percent to $1.5530 as of 12:05 p.m. in London. The yield on the 10-year government bond rose 6 basis points to 2.447 percent.
The U.K. central bank, which left its benchmark interest rate at a record-low 0.5 percent, raised the ceiling for so- called quantitative easing to 275 billion pounds ($426 billion) from 200 billion pounds. That’s the biggest expansion since the first round of stimulus in March 2009. Only 11 of 32 economists in a Bloomberg News survey predicted an increase.
‘Bold Move’
“The external environment has definitely darkened,” said Steven Bell, chief economist at hedge fund GLC Ltd. in London. “Why do we need to wait for them to get their act together? The Bank of England is correct. It’s a bold move, but a good one.”
Bank shares have plunged this year on concern that they will suffer if Greece defaults and as European officials clashed over how to resolve the turmoil. The Bloomberg Europe Banks Index has fallen 30 percent in 2011, compared with a 17 percent decline by the Stoxx Europe 600 Index. Lloyds Banking Group Plc has dropped 45 percent.
“This is the most serious financial crisis we’ve seen at least since the 1930s, if not ever,” King said on Sky News.
While European officials agreed on a second aid plan for Greece in July, they’ve indicated they may reopen the deal to impose larger losses on banks as part of the bailout. The European Commission is pushing for a coordinated capital injection for banks to shield them from the fallout of a potential Greek default.
Reality Check
“The deterioration in the euro zone and the reemergence of risks to the financial system add up to a very different picture from the one we were looking at six months ago,” former Bank of England policy maker Kate Barker said. The Bank of England’s measures don’t imply “they think there isn’t going to be some kind of solution. But it’s recognizing the reality.”
Weakness in U.K. data alone was enough to warrant the additional stimulus, said Michael Saunders, chief European economist at Citigroup Inc. in London, who says the central bank isn’t finished yet. Britain’s economy grew less than initially estimated in the second quarter, with gross domestic product rising 0.1 percent, lower than the 0.2 percent previously published, data this week showed.
‘Great Deal More’
“You need to do it in very large scale to have much impact,” said Saunders. “If the downside risks to the euro area come through, they’ll have to do a great deal more QE.”
U.K. policy makers are prioritizing the recovery over the threat from inflation, which was 4.5 percent in August, more than double the Bank of England’s target. The central bank said that the deterioration in the outlook makes it “more likely” that inflation will undershoot its 2 percent goal in the medium term.
As the bank begins four months of bond purchases, King said he’s “confident” the new measures will work and that policy makers were spurred into action by a sharper-than-expected global slowdown.
“The world economy has slowed, America has slowed, China has slowed, and of course particularly the European economy has slowed,” he said in an interview with BBC Television broadcast yesterday. “That’s affecting our ability to engineer a recovery here so we took action.”
The European Central Bank may also be losing patience with governments, announcing yesterday a resumption of covered-bond purchases and year-long loans for banks. The ECB will spend 40 billion euros ($54 billion) on covered bonds starting next month and will offer banks two additional unlimited loans of 12 and 13-month durations.
“This is the start of a new round of global intervention,” said Stuart Thomson, a fixed-income fund manager in Glasgow at Ignis Asset Management, which oversees $125 billion. “It’s a belated recognition that after a major financial crash, there is a prolonged period of weak, volatile growth.”
To contact the reporters on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net
To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net
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