- By Region
Tight fiscal and loose monetary policy is, in the words of UK chancellor George Osborne, a textbook response to the financial crisis. But across Europe, a slowdown is weakening fiscal stances while a credit crunch is eroding the stimulus offered by central banks.
Had the Bank of England and the European Central Bank not relaxed monetary policy on Thursday – Frankfurt by cutting rates a quarter-point; Threadneedle Street by buying another £50bn of gilts – they would have been complicit in the growing cost of credit faced by households and businesses. Even what they did do is so modest that they are running just to stand still.
In the UK, the average interest rate on small business loans and new mortgages jumped in May; the former’s spread over the BoE’s 0.5 per cent rate is now twice as large as before the crisis. In the eurozone credit is shrinking too. Year on year, the amount of lending to business and households is barely keeping up with inflation. In May, lending to non-financial businesses even shrank in nominal terms.
Both central banks fell short of the real credit boost their economies need. The BoE met modest expectations for asset purchases but could have exceeded them by promising to buy gilts for longer if the economy stays stagnant. More significantly, it did not cut the rate on bank reserves to coax banks into deploying their cash stores on riskier lending. Nor did it show any sign of looking at new ways to bypass the broken banking system to get cash circulating in the economy. In effect, UK business was told to eat “funding for lending” – the credit easing scheme for which details are still awaited.
The ECB, to its credit, did lower its deposit rate to zero in tandem with the main refinancing rate cut. Perhaps this will unclasp eurozone banks’ tight grip on the lending purse strings. But do not bet on it: the banking system is more broken in Europe’s periphery than even in the UK. Banks across Europe are reorganising their balance sheets on national lines, leaving deficit countries’ economies asphyxiated.
As ECB president Mario Draghi acknowledges, the monetary transmission mechanism is not working in swaths of the currency area he is responsible for. To do its job, the ECB must restart buying bonds in the market – this is justified even on its own contorted rationale for these programmes. The European Council’s moves towards banking union gave the ECB political cover for more unconventional support of credit conditions. Instead, it acted solely on the interest rate – the action with the least impact.