The markets may have been unimpressed by yesterday’s Budget. But we will never know. The fall in both the equity and bond markets on Wednesday was all about the emerging banking crisis as the share price of Credit Suisse collapsed, not the Budget.
While British economists were distracted by the Budget, one of the world’s major banks, Credit Suisse, was close to default. The crisis was triggered by a Saudi shareholder owning 10% of the bank saying that his institution would provide no further refinancing to the bank. Overnight, the Swiss National Bank (Switzerland’s central bank) had to provide £44 billion of additional liquidity.
During the previous weekend Silicon Valley Bank (SVB) had collapsed leading to the hastily arranged takeover of its UK assets by HSBC. This looks to have been a highly competent piece of work burning the midnight oil by the Bank of England, the Treasury and HSBC and will do a lot to preserve confidence in the UK tech sector, about a third of the companies in which are alleged to have had relationships with the now defunct bank.
Despite its name, the collapse of SVB had little to do with the well known risks of investing in tech and much more to do with inappropriate hedging strategies against a background of rising interest rates. The problems at Credit Suisse seem to be more endemic and will probably require an investigation to be understood fully. Meanwhile sharp share price falls for other banks suggest that the weaknesses exposed may be widespread.
In these circumstances, US rate rises are likely to be curtailed for the time being, even if this leaves inflationary problems still exposed. The authorities on both sides of the Atlantic will need to keep a sharp eye on other banks.
As all Cebr Prospects Service subscribers will know, Cebr was in the forefront of those warning that the violent monetary expansion over the pandemic risked inflation and hence rising interest rates, a problem that was exacerbated by the Ukraine war. We are surprised that professional bankers did not reach the same conclusions. But since many official central bankers, international institutes like the IMF and official forecasters like the Office for Budget Responsibility also failed to foresee rising inflation, it is hard to single out the bankers alone for blame.
While life would be fairer if the only people who suffered from bankers’ mistakes were bankers themselves, sadly this ain’t so. There are real world economic consequences from the banking crisis.
First, liquidity has dried up at least temporarily. It is likely that central banks will have to inject some liquidity into the markets. But anyone expecting to borrow from a bank, even for a mortgage with a low loan to value ratio, must expect at least to join a queue.
The bulk of bank lending to the private sector in the UK is for mortgages. Although banks lent roughly £25 billion for this in the second half of 2022, the lending was nearly offset by the £21 billion of repayments. It is conceivable that net bank lending to the private sector over the coming months could be negative as banks shore up their capital base.
Second, the pace of interest rate rises will be lower than was expected before last weekend. As ever, the tone will be set by the Federal Reserve Bank. At time of writing the Fed Funds rate stood at 4.58% after the Chairman, Jerome Powell, had followed an aggressive programme of rate rises to curb inflation.
It now seems unlikely that US rates will rise further. Although arguably UK and European rates have some headroom to match US rates (the equivalent UK rate is 4% while that in the Eurozone is 3.5% after yesterday’s rise) we suspect that the UK at least will also limit its programme of rate hikes and quantitative tightening although we are still forecasting a 25bp point rise on a split decision to be announced next Thursday 23 March.
Growth worldwide this year is likely to be slower than it might have been had banks felt freer to lend. Property prices are likely to fall further with mortgages hard to get.
And longer term, ending the counter inflation programme before inflationary pressures have fully been wiped out risks a resurgence of inflation in the coming years. But that is a risk central banks will have to take.
Finally, a second financial crisis within 15 years will undoubtedly lead to additional banking regulation. Even if it is hard to regulate against foolishness.
I wonder (obviously with self interest in mind!) whether banks should be forced to employ independent economic advisers, though there are plenty of economists who also failed to foresee inflation.
For more information contact:
Douglas McWilliams, Deputy Chairman – Email: firstname.lastname@example.org – Phone: 07710 083652
Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.