King: Credit Easing, Not Quantitative Easing

With the outlook for the global economy deteriorating, BOE Governor Mervyn King has presented the markets with a couple of tricks up his sleeve to protect the British economy. In a speech late last week, the BOE head honcho said that a potential Greek exit from the euro zone as well as slowing growth in China have given the central bank more reason to implement easing measures.

On the domestic front, the situation doesn’t look promising either. Since last month when the BOE cut its growth forecasts for the U.K. economy, we’ve seen further weakness especially in the manufacturing sector.

The manufacturing PMI printed at its 3-year low at 45.9 in May. Meanwhile, it was reported that manufacturing production contracted by 0.7% in April erasing most of its 0.9% growth in March.

A lot of market junkies who were paying attention to King’s speech were expecting him to announce that the central bank will resort to quantitative easing (QE) once more. You see, the bank finished its last round of QE last May after it bought 325 billion GBP of government bonds.

However, they were disappointed. Sure, King acknowledged that the option of pumping more money into the economy has gotten more attractive amid signs of slower growth. But still, he rejected calls to go back to QE… for now.

So how does the BOE plan to protect the economy?

Short-Term

First up on the BOE’s arsenal is providing banks with emergency funds just in case the euro zone’s situation gets worse and makes it difficult for banks to have access liquidity.

In order to do this, the central bank will tap its Extended Collateral Term Repo (ECTR) Facility which was launched last December 2011. Basically, it’s a program that will auction off 5 billion GBP worth of six-month loans to banks in exchange for a wide range of collateral.

Auctions will happen at least once a month starting June 20 and banks can bid for a minimum of 5 million GBP at interest rates of at least 0.75% or higher.

Long-Term

Coordinating with the British Treasury, the department charged of keeping an eye on the U.K.’s balance sheets, the BOE will allow banks access to loans with 3-4 years maturity at interest rates lower than market rates. In exchange, banks need to issue more credit to households and businesses.

The program will ease tight credit conditions in the country by reducing the funding costs of banks. Consequently, the BOE and the Treasury hopes that it could give banks an incentive to lend more and eventually help lower the costs of loans and mortgages.

Chancellor of the Exchequer George Osborne said that the government will set aside about 80 billion GBP worth of new loans in the coming weeks for the plan.

Market Reaction

We saw barely any reaction in GBP pairs at the wake of the announcement. GBP/USD just traded around the 1.5550 minor psychological handle hours after Mervyn King made his speech. However, a handful of market junkies think that the pound’s slide during the start of the London session can be attributed to the mere mention of the possibility of QE for the British economy.

GBP/USD Chart

But the pound quickly pared its losses and traded higher. Why? Well, my guess is that it was not really a surprise that the Brits have come up with their own measures to safeguard their economy. It seems that most central banks are also bracing themselves for the worst as well.

In this humble not-that-old man’s opinion, the BOE’s wait-and-see approach to get liquidity flowing in the U.K. economy before resorting to QE may have even been bullish for the pound. Investors might have felt a sense of relief knowing that British officials have not-so-dire plans in place in case the euro zone does break up.

Then again, that’s just me.