Wednesday, June 26, 2013

Bank of England warns banks of risk of sharp global interest rate rise

Reuters is out with an intriguing bit of news.

Mervyn King, the governor of the Bank of England, has issued a stunning warning:
The Bank of England warned banks and borrowers on Wednesday about risks from a potential abrupt rise in global interest rates, and said banks might need to further bolster their capital cushions to protect against this.

The past week has seen a sharp rise in global bond yields since U.S. Federal Reserve Chairman Ben Bernanke said that the U.S. central bank may scale back bond purchases later this year.

BoE Governor Mervyn King said on Tuesday that markets had "jumped the gun" in their sharp reaction to Bernanke's comments, but the BoE's half-yearly Financial Stability Report said more bond yield rises could hurt UK banks, insurers and borrowers.

The BoE said that it had ordered an investigation into the vulnerability of Britain's financial institutions and borrowers to higher interest rates, to report back by September to its new risk watchdog, the Financial Policy Committee.

"Financial institutions and markets are also vulnerable to an abrupt rise in global interest rates. And some UK borrowers remain highly indebted, which could result in losses for UK banks," the FPC said.
It's an intriguing statement because King, as we all know, steps down at the end of this month as the head of the Bank of England.

His replacement? Former Canadian central bank chief Mark Carney, who many economists expect to advocate a long-term commitment to low interest rates as a way to keep down bond yields.

King's call for higher capital requirements has bankers privately complaining that higher capital requirements and limits on leverage are hampering their ability to lend. But this is strongly disputed by the BoE, which says healthier long-term capital levels make it cheaper for banks to borrow.

Wednesday also saw the BoE allow banks to scale back some of the short-term cash they hold against shocks to encourage more lending to the economy.

Many believe the BoE is a long way from tightening monetary policy, and a minority of BoE rate-setters have been voting for more stimulus for the past few months due to the weak state of Britain's economic recovery.

So what gives with Mervyn King and his warnings of a sharp global interest rate rise on the eve of his departure of BoE governor?

Is his looming retirement giving him the freedom to say what he really fears?


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  1. China has issues as well...CAD we weaken even further...perhaps to 85 US cents. I'm happy for real estate prices going down (that grew 300% over past 8 years) but we all here in BC face a deep dive ahead...

  2. not a feng shui expertJune 28, 2013 at 7:21 AM

    I haven't read the speech, but this was pointed out on page 3 of King's speech (I've emphasized in capitals):

    "The present extraordinary monetary policies cannot, however, continue indefinitely. Both nominal and real interest rates are at unsustainably low levels. There is an understandable yearning for a return to normality. And in recent weeks bond yields have risen – up around 45 basis points since the start of May. But such market moves should not be confused with a return to normality.

    A rapid return to higher interest rates would do great damage to the balance sheets of highly indebted households, companies and, especially, financial institutions. The challenge in returning to normality is not so much managing market expectations when that eventually happens, important though that is, but in creating the economic conditions in which it is sensible to return to more normal levels of interest rates. The real challenge – on a global scale – is to rebalance the world economy so that very low interest rates are not required to exhort deficit countries to spend in order to absorb the surpluses elsewhere.

    Monetary policy cannot provide the answer. It can only buy time to bring about the necessary structural changes in investment, trade and capital flows. WHETHER THEY INVOLVE CHANGES IN CURRENCY VALUES OR RESTRUCTURING OF DEBT IS A POLITICAL CHOICE, but a failure to deal with global imbalances will not only retard the recovery in the world as a whole, but worsen the scale of the adjustment ultimately needed. It will inevitably be a bumpy ride."

    The restructuring of debt is an interesting mention from a central banker, even if he is outgoing. I can see it being very pertinent to the Euro situation, but for a global scale... that's going to involve huge readjustments that could be huge debt restructures for the globe's indebted nations (and we know who they are, unfortunately).

    Unless you think China is really going to, as Michael Pettis thinks is necessary, switch to supporting their domestic consumption instead of investing at world-historic levels of production - and fairly soon in order to correct these imbalances without the alluded-to debt defaults occurring.