Paul Fisher: Financial markets, monetary policy and credit supply
Speech by Mr Paul Fisher, Executive Director for Markets of the Bank of England, Member of
the Monetary Policy Committee, to Richmond University, London, 2 October 2013.
* * *
Thank you for having me back at Richmond University. In this lecture today, I aim to review
the behaviour and development of financial markets over the past year, including the period
of heightened volatility since May and the introduction by the Monetary Policy Committee of
explicit forward-looking monetary policy guidance in August. I will also assess the working
and impact of the Funding for Lending Scheme over its first year of operation.
Developments in financial markets
When I spoke to you a year ago, financial markets were still scarred by the crisis years and
there remained a number of significant downside tail risks to the global economy. Contacts
were citing: the risks of a breakup of the euro-area; the possibility of a "fiscal cliff" in the US;
a slowing in China, alongside already weak growth in the advanced economies; and tensions
in the Middle East - especially around the Straits of Hormuz. But those tail risks were seen to
be offset in large part by the commitment of central banks to respond. The ECB had
announced its Outright Monetary Transactions programme and had been interpreted as
publicly committing to do whatever it takes to keep the euro-area together. The FOMC
similarly committed to keep the US economy growing, with state-contingent forward guidance
being issued in December 2012. The MPC had voted to increase its stock of asset
purchases to £375 billion in July 2012 and introduced the Funding for Lending Scheme
(FLS). Taken together these factors were generating a growing "hunt for yield", initially
cautious and focussed on relatively simple, liquid financial instruments but gradually
expanding, especially in terms of credit risk - for example "high yield" bonds were in
particularly high demand, leading to historically compressed spreads.
Since then, we have seen a game of two halves. If I move on to around April this year, the
picture had changed substantively relative to the autumn. The previously perceived tail risks
were fading from discussions. Europe was making progress on a number of structural
reforms, including moving towards a banking union. A mini-crisis in Cyprus had been dealt
with, without too many spillovers. Spreads over bunds for sovereign debt of the larger
vulnerable euro-area economies had narrowed considerably. The US "fiscal cliff" at end-2012
had passed by with some relief (although concerns about the processes associated with the
US fiscal deficit have now resurfaced). While fiscal consolidation might have slowed US
growth somewhat, the process of adjustment around the turn of the year had been smoother
than feared and the macroeconomic repercussions rather less. China had injected some
renewed stimulus and Japan had introduced a far reaching new economic framework of
quantitative and qualitative easing to improve the outlook there. At that time, Middle East
tensions had not induced further Western military intervention and the oil price had been
relatively stable, falling to around the $100pb mark. One could argue that central banks
- and other authorities - had validated expectations.
During this period from the Autumn of 2012 to the Spring of 2013, financial markets were
relatively calm but periods of "risk on" were lasting for longer and leading to greater risk
taking. Equities and other risky asset prices generally rose. Interest rates were low and
stable at the short end and increasingly depressed at longer maturities as the FOMC
maintained its asset purchase programme. The hunt for yield intensified, especially down the
credit spectrum, with some investors being driven by return targets, mandates and
benchmarks rather than a true reflection of risk-adjusted returns. The volatility of market
prices also became compressed during this period (Chart 1).
Chart 1
Implied volatility from various asset markets
27 Feb 2009
Standard deviations from mean
01 May 2013
since 2006
USDGBP
16 Jul 2013
3
Japan long rates JPYUSD
2
1
Japan short rates USDEUR
0
-1
US long rates -2 FTSE 100
US short rates S&P 500
UK long rates Nikkei 225
UK short rates
Chart 2 shows a "heat map" constructed by colleagues in the Bank's Financial Stability
Directorate, showing how market functioning has changed over time based on issuance
levels and spreads. It tracks how most markets have continued to improve towards normal
levels (on these indicators at least). An interesting exception is markets for bank funding
instruments in Europe, which have become subdued as commercial banks have de-levered
and central bank operations have provided cheap medium-term funding in large scale.
Perhaps the worst functioning is the market for CMBS which has still not really returned in
the UK (in contrast to CLOs which have made a comeback this year).
Chart 2
Market functioning "heat map" based on issuance and spreads data(a)(b)
United States
United Kingdom
Corporate bonds Euro area
United States
Bank bonds, United Kingdom
unsecured Euro area
MIRP
United States
United Kingdom
NN NNNNNNNNNNNNNNNNN NN N NN N N NNN
RA
RMBS Euro area
N N N NNNNNNNNNNN N N N NN N N N
United States
Y N N NNNNNNNNNNN N N
United Kingdom
NNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNN
CMBS Euro area
N NNN NNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNNN N
United States
United Kingdom
Corporate bonds Euro area
United States
Bank bonds, United Kingdom
Euro area
unsecured
United States
United Kingdom
RMBS Euro area
United States
YRADNOCES
Euro area
CMBS
2007 08 09 10 11 12 13
Very loose Loose Normal Tight Very tight No Issuance
Sources: Bloomberg, Dealogic, JP Morgan Chase & Co, Bank of America Merrill Lynch and Bank calculations.
(a)
Shading is based on a score that reflects gross issuance (relative to nominal GDP) and spreads in primary
markets, and spreads in secondary markets, expressed as a number of standard deviations from its historical
averages, using as much data as available data from January 1998. Primary market indicators reflect the past
three months, so smooth volatility. Where spreads are not available, indicators are based solely on issuance.
(b)
Latest data point is August 2013.
Given such benign conditions it seemed natural to ask whether firms were prepared for the
risk of a sudden change in conditions - in particular the possibility of a snap back in interest
rates at some point. In early April, such questions to contacts usually evoked a blank
response! Those who had been betting on rates rising had consistently lost money and such
positions generally had been cut. There were few visible signs of any increase in hedging
activity other than reports that some investors preferred floating rate rather than fixed rate
products at the margin. A lot of faith seemed to be enshrined in the ability to anticipate the
FOMC: that it would signal clearly and early what its strategy would be, leading to a smooth
exit from its policy stance. Altogether the market was ripe for some volatility consequent to a
change in the policy outlook. That volatility duly arrived.
The initial catalyst was the strong US non-farm payrolls data on May 3rd after which longer
term yields started to rise. But there was not a wider market reaction at that point. It was
22nd
Bernanke's comments on May that the FOMC could begin tapering its asset purchases
"in the next few meetings" which caused a widespread reassessment of risk positions. What
followed was a good illustration of what can happen when there is a general sell-off. Initially
asset price correlation increased and liquidity became poor across markets. Because the
news related to a prospective policy tightening, risk-free yields generally rose (Chart 3),
although at least some of this was a change in term premia rather than rate expectations.
Equity markets fell. Some contacts described conditions as highly volatile. EME assets in
particular were badly affected as leveraged investors cut their risk positions quickly in those
markets (Chart 4). Eventually, as conditions settled, there was more discrimination between
and within asset classes. For example, there has been much more distinction between those
EMEs whose fundamentals were seen to be relatively sound and those who were seen to
have challenges - in this latter group were especially those with both a large external deficit
and high inflation.
Chart 3 Chart 4
Selected ten-year government Emerging market equity indices
bond yields(a)
Indices: 22 May 2013 = 100
Spain Italy UK
Per cent
May 22nd
120
9
US Germany
May
May
22nd
3rd
8
110
7
100
6
5
90
4
South Africa
Korea
80
3
China - Shanghai
India
2
Mexico
70
Brazil
1
Turkey
Indonesia
60
0
Jan. Feb. Mar. Apr. May. Jun. Jul. Aug. Sep.
Jan Mar May Jul Sep Nov Jan Mar May Jul Sep
13
2012
2013
Sources: Bloomberg and Bank calculations
Source: Bloomberg.
(a)
Yields to maturity on ten-year benchmark
government bonds
Although the sell-off has been wide ranging and left several EMEs with difficult policy
challenges, I don't sense any long-lived market dysfunction. Market infrastructures worked
and prices adjusted to the revised policy outlook. Yes, volatility rose, but not to levels which
are particularly unusual for such episodes The most highly leveraged positions -
(Chart 1).
such as in mortgage REITs1 - were reported to have liquidated quickly, and some ETFs2,
primarily fixed-income, came under liquidity pressure. Those institutions with short trading
horizons and leveraged positions may have found conditions very difficult at times to adjust
portfolios. Although it is clear that a number of firms must have made substantial losses on
the positions they had, there have not been many visible signs of severe financial distress.
For most longer-term investors the stress has been seen as rather limited. Credit spreads
have not particularly blown out with rising "risk-free" rates. For example, yields on Italian and
Spanish bonds were remarkably stable for most of this period; advanced economy equity
prices largely recovered; and "cov-lite" loans have continued to be issued at a record pace.
Overall the system seems to have survived in reasonable shape and for many market
participants the "shock" is seen as a healthy correction to what had become a complacent
outlook.
As reported in the record of the recent FPC meeting published yesterday, staff from the FCA,
PRA and Bank have carried out some analysis of the sensitivity of borrowers and financial
institutions to upward movements in long-term interest rates and credit spreads.3 That
preliminary work suggested that "a moderate rise in long-term interest rates did not pose an
immediate threat to major banks and insurance companies. But borrowers would become
more exposed to an increase in interest rates were debt levels to rise. And counterparty
classes with higher leverage or exposures to market liquidity risk or credit spreads were
more affected...". The Committee did not draw too much comfort from this assessment and
has asked that more detailed work be done to assess the risks.
What have we learned from this episode? I will pick out a few of the highlights for discussion.
First let me note that the "stress" so far has not involved any actual exit from accommodative
policies in the advanced economies. The change in the outlook was initiated by speculation
adding
about the possibility that the FOMC might start to slightly reduce the rate at which it is
stimulus! It would have been a more severe stress if policy rates had actually been changed.
Many firms for whom maturity transformation is a major part of their business model will
actually be better off if the short-term rates at which they fund themselves are relatively
unchanged while longer-term rates rise.
Have markets got it wrong? If so then in my view that was not obviously in the price reactions
since May (although the extent of the fixed-income sell-off may turn out to have been
overdone, especially for the UK) - rather it was the expectations that had become embedded
prior to May which had become overly certain even if, at that time, it supported the intent of
monetary policy in both the US and Europe.
It is important to remember that monetary policy is about decision making under uncertainty.
Considerable uncertainty. Policy makers get surprised by economic developments just like
everyone else, and that news is often visible to the market before the authorities can even
think about the right responses, let alone respond to them. If I, as a policy maker, am
uncertain about how policy will evolve, how can the market be so much more certain? I am
continually struck by the degree of certainty some market participants seem to have about
prospective monetary policy decisions, particularly those of the FOMC. In general,
communication from monetary policy setters aims to convey details of our reaction functions
- how policy might change in reaction to future data or other news - it is not aimed to convey
the outcome of a decision that has yet to be made! The best we can usually do is to set out
how we are thinking about the outlook so that market participants and others might be able
dynamically to gauge our response as the data and events reveal themselves. Forward
guidance, on which more shortly, can add to that understanding but the actual outcome for
policy will always be dependent on how the economy, and hence the outlook, evolves.
Can we learn anything about the impact of large scale asset purchases - or quantitative
easing - from this recent episode? More work will have to be done on this as a case study
but, at face value, the fact that US Treasury yields could move by over 100bps just on
speculation of a small reduction in the rate of purchases, confirms that asset purchases in
the US must have been having a very sizable effect on market prices, at least as large as the
quantitative estimates that have previously been made.4 And the degree of reaction in UK gilt
yields makes it clear that there have been large international spillovers - a point which some
previous research has also noted.5 The degree of correlation since May has been striking
and for shorter-term rates, it is possible that it has been exacerbated by poor liquidity in
money markets and hence over-done. Given how the recoveries have differed in scale and
nature - the US economy has grown much more than the UK since the recession, and has
not suffered the same collapse in productivity - one would surely expect the prospects for
monetary policy to be quite different in the two jurisdictions.
A final issue I want to raise is whether market behaviour has been affected by regulatory
changes. Over the past year or so many of the reforms being introduced internationally have
been implemented or anticipated. In particular the future rules on capital and liquidity have
become clearer, and proprietary trading has largely relocated away from the traditional
intermediaries as a result of the "Volcker Rule". The past five months has been the first
stressful period since those changes. Many market contacts have suggested that liquidity
during the recent sell-off has been worse than it would have been because the dealers are
no longer willing or able to absorb volatility by taking client positions onto their balance sheet.
They argue that the dealers' ability and willingness to make markets has been much
reduced. This is a subject of ongoing consideration in the official community. But we have to
bear in mind that in a rapidly moving market, regardless of the regulations, no one has ever
really wanted to "catch the falling knife". And investors have always needed to be aware that
crowded trades will hit a bottleneck if everyone tries to exit at the same time. On EME assets
for example, liquidity during a "risk off" period has always been limited. In my view, we can't
draw any hard conclusions on this topic yet and more evidence is needed.
Forward guidance
It was in an environment of increased volatility that the MPC decided at its August policy
meeting to provide some explicit guidance regarding the future path of our monetary policy
instruments. Since our announcement it has been suggested that this policy is overly
complicated. I disagree. The policy was summarised in a single sentence in our explanatory
document:6
"In essence, the MPC judges that, until the margin of slack within the economy has narrowed
significantly, it will be appropriate to maintain the current exceptionally stimulative stance of
monetary policy, provided that such an approach remains consistent with its primary
objective of price stability and does not endanger financial stability."
In case that's not sufficiently simple, let me put it the other way round: we remain committed
to returning CPI inflation to its 2% target in line with our remit but, in doing so, we will not act
in a way which would risk choking off the recovery prematurely, given the potential for a
substantial amount of spare capacity in the economy.
The technical details of the policy are needed to make this precise so that it can be
implemented and monitored: the MPC intends not to raise Bank Rate from its current level of
0.5% at least until the Labour Force Survey headline measure of the unemployment rate has
fallen to a threshold of 7%. The MPC stands ready to undertake further asset purchases
while the unemployment rate remains above 7% if it judges that additional monetary stimulus
is warranted but will otherwise maintain the stock of asset purchases and will reinvest the
cash flows associated with all maturing gilts held in the Asset Purchase Facility.
This guidance linking Bank Rate and asset sales to the unemployment threshold would
cease to hold if any of the following three "knockouts" were breached:

if, in the MPC's view, it is more likely than not, that CPI inflation 18 to 24 months
ahead will be 0.5 percentage points or more above the 2% target;

if medium-term inflation expectations no longer remain sufficiently well anchored;

if the Financial Policy Committee (FPC) judges that the stance of monetary policy
poses a significant threat to financial stability that cannot be contained by the
substantial range of mitigating policy actions available to the FPC, the Financial
Conduct Authority and the Prudential Regulation Authority in a way consistent with
their objectives.
Explicit forward policy guidance can enhance the effectiveness of monetary stimulus in three
ways. First, it provides greater clarity regarding the MPC's view of the appropriate trade-off
between the speed with which inflation is returned to the target and the support given to the
recovery. Second, it can reduce uncertainty about the future path of monetary policy as the
economy recovers. And third, it delivers a robust framework within which the MPC can
explore the scope for economic expansion without putting price stability and financial stability
at risk.
This latter point is especially important to grasp in order to understand the intent of the policy.
Since 2008, aggregate productivity in the UK - measured as output per hour worked - has
behaved unlike any previous recession/recovery. The level of productivity in the economy as
a whole today is around 15% below where it would have been on an unchanged long-term
trend. We don't know how much of this productivity gap can be reclaimed. But if even only a
small part could be recovered then output should be able to grow strongly for some years
without generating much inflationary pressure. In particular, firms should collectively be
carrying enough spare labour to expand output without putting pressure on the labour
market. Unemployment would consequently fall slowly relative to normal experience, for a
given rate of output growth.
It is important to stress that forward guidance is not a guarantee to hold rates where they are
for a set period of time, as has been widely mis-reported. The guidance is given in the form it
is precisely because the outlook is uncertain - it allows us to explore how much spare
capacity there really is in the economy before raising Bank Rate.
Much has been made of the market reaction to forward guidance since its launch, with
market prices currently implying that Bank Rate will rise by 25 basis points by the middle of
2015, around six months earlier than at the time of our August meeting. I think there are a
range of reasons for that and it does not necessarily imply that forward guidance "isn't
working". First, gauging the "market reaction" depends who you ask. Surveys of economists
by Thompson Reuters and by Bloomberg have indicated that the median expected timing of
the first increase in Bank Rate has been pushed later since our announcement (Chart 5).
Second, there has been UK specific news which might have justifiably caused UK rates to
have risen somewhat: the positive flow of economic data since the start of August has been
consistently stronger than market expectations. Third, UK rates have clearly been pushed up
by international developments. The correlation in short rates between the UK and US is
unhelpful given the relatively subdued recovery in the UK and, as I have already noted,
somewhat puzzling. It probably, in part, reflects continuing poor liquidity in sterling money
markets over this period. It may well be the case that these rates decouple in future as
liquidity improves and the outlook for each economy develops further.
Chart 5
Indicators of when Bank Rate is expected to have risen
August
Implied by OIS(a)
Inflation
Date
Latest Reuters poll(b)
Report
2017
2016
2015
Mar Apr May Jun Jul Aug Sep
2013
Sources: Bloomberg, Reuters and Bank calculations
(a)
Series is calculated as the first date at which instantaneous forward
OIS rates equal or exceed 0.75%
(b)
Reuters poll shows the median of economists' expectations of the first
rise in Bank Rate. This is based on a survey of economists' responses to
the question: "When do you expect the Bank of England to change rates
next?"
Whatever the explanation for the recent rise in interest rates, we do not intend to maintain a
running commentary on whether the market has got it right or wrong in relation to when Bank
Rate will rise. Monetary policy is a medium-term game, and its success or failure cannot be
judged over a matter of weeks or by volatile price movements. If market expectations are in
the wrong place then market participants will realise that in due course and rates will adjust.
In any case, in my personal view, the biggest impact from forward guidance was never going
to be from trying to shift the sterling market curve around - it is still pretty flat for 2 years
ahead. The important thing is to get the message across to businesses and households
about what the outlook for monetary policy really is. Concern that interest rates will rise as
soon as growth returns may well have been a factor already holding back the recovery.
It's a case of so far, so good, on that front. The early reactions we are getting from
individuals or groups of business people generally suggest that they have got the message
and that will be adding to confidence. For example, the Bank's latest public survey shows a
marked reduction in the proportion of people expecting a rise in interest rates over the next
year - it's currently the lowest reading since Bank Rate was cut sharply in late 2008 at the
height of the financial crisis. So in terms of supporting the real economy, I think the policy is
working.
Forward guidance is an important part of the broader mixed strategy the Bank is employing,
using many of its tools to secure the recovery while not taking risks with inflation or financial
stability. For example, the FPC and PRA have been working to ensure UK banks and
building societies have sufficient capital to help support and sustain the recovery. And they
will remain vigilant to make sure that macroeconomic stimulus does not translate into
imprudent lending behaviour. Another strand of policy is the Funding for Lending Scheme,
which is where I would like to turn now.
The Funding for Lending Scheme: one year on
It was on the day of this lecture last year that the Bank of England announced the first
13 banks and building societies to have signed up to the FLS. There are now over 40 firms
participating, representing over 80% of the stock of lending to the UK economy. The total
amount of outstanding drawings under the Scheme is over £17bn and rising. The MPC has
been using a wide range of indicators at various stages of the transmission mechanism to
help assess the extent to which credit conditions have improved since its launch. Let me run
through those.
Stage 1: bank funding costs
Our first objective was to reduce bank funding costs - and this phase has been remarkably
successful. Over the past year, those costs have fallen sharply Of course, they are
(Chart 6).
likely to have been affected by developments internationally, including Mario Draghi's "do
whatever it takes" remarks in July 2012. But usually sterling funding markets would react by
less than euro-denominated markets to European developments. In fact, UK unsecured bond
spreads fell further in the UK than in core euro-area countries - indicative of an additional
boost from the FLS over and above general market developments.
Indeed, funding conditions have improved so much (not just in prices but in terms of
quantities) that it is safe to say that bank funding is no longer a constraint on lending for most
UK banks - the larger banks tell us that they are "awash" with liquidity. If you were to go back
around two years, tightening funding conditions for the banking system was one of the big
issues policy makers and banks were discussing, and it's striking to see how conditions have
changed completely since then. Costs have come down so much that some banks have
been able to get funding in the market as cheaply, or cheaper, than we are providing in the
Scheme. This is important to understand - it means the scale of FLS draw downs is not a
measure of success. In fact the more stressed market conditions are, and the higher market
funding costs rise, the more we would expect banks to draw from the Scheme. Going
forward, the FLS should help to keep funding costs down by serving as a backstop marginal
funding source if market funding costs were to rise.
Stage 2: quoted terms and credit availability
The second stage in achieving our objective was a reduction in lending rates to the economy
and an improvement in credit availability. This has happened, albeit more slowly than initially
anticipated. On average we've seen rates on two-year fixed rate mortgage products come
down by around 110bps since the FLS was announced, and floating rate mortgages by a bit
less (around 60bps) (Chart 6). The availability of household credit, particularly secured
credit, has improved according to recent Credit Conditions Surveys by the Bank of England.
Chart 6
Changes in quoted mortgage rates and indicative UK bank
funding costs over the first year of the FLS(a)
Change in mortgage rate
Percentage
Change in bank funding cost(b)
points
0.0
-0.5
-1.0
-1.5
-2.0
75% LTV 75% LTV 75% LTV 90% LTV
two-year two-year five-year two-year
fixed-rate fixed-rate fixed-rate
floatingrate mortgage mortgage mortgage
mortgage
Sources: Bank of England, Bloomberg and Bank calculations.
(a)
Change between 30 June 2012 and 30 June 2013.
(b)
For fixed-rate mortgages, calculated as the sum of indicative UK bank
secondary market bond spreads and the swap rate corresponding to the term
of the mortgage. For floating-rate mortgages, three-month Libor is used in
place of a swap rate. For more details see Chart 1.8 of the August 2013
Inflation Report.
It's harder to measure what has happened to lending rates to businesses as the borrowers
and loan products available are less homogenous than in the household sector. Lenders
report that loan spreads have fallen for companies of all sizes, and that credit availability has
increased, but the improvement has been less marked for small and medium-sized
businesses. We have seen banks take different approaches to SME loans: one bank has
scrapped some of its arrangement fees, another is offering guaranteed discounted borrowing
costs and another offers a cash back scheme. So one can't capture the impact of the FLS on
the cost of borrowing for businesses in a single simple, headline, interest rate measure.
Survey evidence from the Federation of Small Businesses suggests that the pricing of loans
for small businesses was more favourable in 2013 Q2 than in mid-2012 - but availability was
reportedly poor. So it's a mixed picture overall for SMEs. Going forward, SME credit
conditions should be supported by the extension to the FLS announced in April, which
provides additional incentives for participants to increase lending to SMEs both this year and
in 2014. A large proportion of FLS participants have indicated their intention to participate in
the extended Scheme.
It is likely that any person or business who has borrowed from a bank since the middle of last
year will have done so at a cheaper rate than they would have done in the absence of the
Scheme. If so then the FLS will have had a monetary impulse on the economy. We think that
the FLS will continue to bear down on lending rates to households and businesses in the rest
of this year and beyond.
Stage 3: loan applications and approvals
The next stage is for the reduction in rates to induce an increase in the demand for credit. A
key parameter for the response in quantities is the price elasticity of demand for credit. We
have been hearing lots of positive comments about the state of demand in the housing
market since early in the year: from builders, estate agents, lenders and contacts of our
regional network of Agents, and this has recently reflected into an improvement in the data.
Let me note that although the housing market is clearly gathering momentum, and house
prices have started to hit the headlines, I must say that don't see any evidence of bubble
behaviour as yet, with mortgage lending still subdued relative to what is likely to be normal
levels of activity. The housing market is recovering from a number of years of very low
transactions, with house prices having risen well below the inflation rate. It is not surprising if
we see an adjustment of relative prices when the market recovers and of course London has
special demand pressures which are not present elsewhere in the UK, especially for
highend housing. But we may well see a response in new housing supply in due course, limiting
the effects of demand on house prices. Let me assure you that the Bank will not be
complacent about allowing financial stability risks to build through an over-expansion of the
housing market. Both borrowers and lenders need to be careful not to over-stretch
themselves. In line with the recent FPC statement, we will be keeping a very close eye on
developments, and the Bank has a range of tools that can be used in mitigation of those
risks.
Stage 4: the flow of credit
Annual growth in the stock of lending to households and businesses has remained close to
zero since mid-2012, similar to rates seen in the run-up to the launch of the FLS. But it is
important to bear in mind that prior to the announcement of the FLS, the Bank judged that
UK bank lending was more likely to decline than increase over the following eighteen
months. The profile of lending seen to date has been broadly in line with our original
expectations: the trend in household net lending has been somewhat stronger than expected
before the launch of the FLS and net lending to businesses has been perhaps a little weaker.
We were also conscious that the stock of credit depends on both supply and demand. We
were sure that the FLS would shift supply but the demand effects were always less certain.
The price elasticity for firms in particular is likely to be low. It is possible at the margin that
some firms will be better able to repay or refinance loans if their borrowing costs are a bit
lower, but this effect is probably small relative to the importance of expected demand for a
firm's products. So the scale of response in the overall flow of credit to businesses depends
in part on a wider confidence effect shifting the demand curve. We may finally be seeing that
restoration of business confidence in which case the flow of credit to businesses should pick
up.
Beneath that aggregate narrative, there are some revealing stories in the details. The data
we publish each quarter reveal material differences in net lendin