Britain Hasn't Failed the Moral Hazard Test

Marcus Ashworth
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Britain Hasn't Failed the Moral Hazard Test

(Bloomberg Opinion) -- Andrew Bailey, the new Bank of England governor, was at pains in an FT interview on Sunday to draw a clear distinction between the BOE’s bulk buying of bonds and its direct financing of the British government’s coronavirus spending plans. The latter simply wasn’t going to happen, he said, because it would damage the central bank’s credibility in pursuing its defining mission of controlling inflation.

So it’s embarrassing for Bailey that the line between the BOE and the U.K. Treasury got a little more blurred on Thursday, with the announcement of a temporary extension to the government’s overdraft at the BOE. While this is more of an insurance policy than a signal that the bank is immediately about to start printing money to let Boris Johnson’s administration run up a bigger deficit, the move would still allow the Treasury to avoid having to brave the bond markets if it decided that were necessary. This facility rose to almost 20 billion pounds ($25 billion) during the financial crisis, though that could easily be exceeded this time.

This is another sign of the Treasury and the BOE acting in lockstep, something that has worked pretty well during the coronavirus crisis, but it would probably be overstating things to say that it challenges the independence of the central bank. Claims that it creates real moral hazard, by encouraging a consequence-free splurge by the government, are also overdone.

Having access to this tool is sensible contingency planning as the Treasury’s immediate daily funding needs during the lockdown have soared to as much as 2.5 billion pounds daily, and it may not be practicable to rely solely on the government bond and short-term money markets. U.K. markets took Thursday’s news in their stride, with 10-year Gilt yields falling three basis points to 35 basis points, and the pound was little changed at $1.24. 

For monetary purists, it’s a terrible thing for a central bank to fund state spending, but rules are being suspended everywhere during this crisis. Chancellor of the Exchequer Rishi Sunak’s job retention scheme for furloughed workers has been substantial and his measures to support small- and medium-sized businesses start next week. There needs to be enough cash ready; this is really just a safety net to make sure there’s no short-term gap.

Keeping the Gilts market functioning with such a weight of upcoming supply is for the greater good. Maintaining confidence that there won’t be a buyer’s strike is paramount.

The last thing needed is a failed gilt auction. Estimates of gilts issuance this financial year are approaching 300 billion pounds, double last year’s figure. But investor demand has been very strong so far, helped by the BOE’s purchases in the secondary market.

There is a balance to be struck on moral hazard, and these temporary relaxations of the rules do tend to become permanent: Quantitative Easing was unveiled a decade ago, and was only meant to last until the financial crisis passed. But we can have that argument later. In the next few days and weeks, everybody just needs to make sure the cash is available to stop the real economy from imploding. These are unprecedented times.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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