The British central bank finances the state directly

The Bank of England is the first western central bank to give the UK state direct money. This should help to cushion the enormous costs of the measures against Corona.

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The enormous economic aid due to the corona crisis puts very high debts on many countries in a very short time. In the UK, the central bank is therefore preparing to fund the treasury directly to a considerable extent. From the regulatory point of view, what can be extremely alarming is initially a technical adjustment for the Bank of England. It extends the overdraft facility that Prime Minister Boris Johnson’s government can draw on her to an undisclosed extent, as announced on Thursday. In other words, the British government has probably unlimited “overdraft facilities” with the Bank of England.

The state urgently needs money

The need for money has exploded: in the fight against the consequences of the corona crisis, the British government has provided grants, aids and loans amounting to around 5% of gross domestic product (GDP) plus loan guarantees of just under 15% of GDP. Added to this are the tax losses caused by the slump in economic life. In the current month of April alone, the UK wants to raise £ 45 billion (CHF 54 billion) – three times more than planned in March and also more than at the height of the financial crisis.

The Bank of England is the first western central bank to provide direct public finance in the corona crisis. However, the door should not be opened, as the central bank points out. The government will ultimately fund the crisis measures against the pandemic in full through normal borrowing on the capital market. All money that the government uses with its “overdraft facility” will be repaid to the Bank of England by the end of the year. The capital market remains the state’s primary source of money. The higher credit line should only allow the government to “smooth” its cash needs, the Bank of England said.

A tool from ancient times

With this monetary easing, the new governor Andrew Bailey is taking a step he thought was unthinkable just a month ago. In mid-March, he told journalists that the overdraft facility was a historical instrument and, by analogy, none that was currently on top of the toolbox. Admittedly, the so-called ways-and-means facility, which is at issue here, is an old institution. In the years before the central bank gained independence, it served the government to make cash management easier in the short term.

After the turn of the century, a new authority took over this task. It was part of a major reform, which was also necessary under pressure from the European treaties to avoid conflicts of interest between the state budget and monetary policy. The facility has been seldom tapped, most notably in the global financial crisis, where the government borrowed just under £ 20bn from the Bank of England. But mostly, and most recently, it was only £ 370m.

Investors are still willing

Lately, however, it has not seemed as though the UK government is struggling to raise money on the capital market: this week it raised £ 2bn in ten-year government bonds (gilts) – and received almost four times the amount Bids, which made the auction more exaggerated than ever since at least 1998. At auctions of bonds with different terms, the picture was similar to that of the benchmark bond. A three-year paper, which was three times oversubscribed, could be sold by the state at the lowest interest rate in the history of the Gilts. Two key rate cuts by the central bank also play a role here, which have pushed the key interest rate from 0.75 to 0.1% since mid-March.

Nevertheless, the Bank of England emphasizes that the big “overdraft facility” for the government should help to ensure that the markets function properly. Because just as the Corona crisis does not lead to a normal recession, investors also do not always act as is normal in times of great uncertainty: in March, they briefly sold government bonds of many industrialized countries that were actually considered safe, although these would otherwise be in crisis are targeted as “safe havens”. The yield on British government bonds with a ten-year term quickly climbed from below 0.2 to up to 1%.