27th September 2016 marked the launch of the Bank of England’s new Corporate Quantitative Easing (QE) programme. The Bank will now be creating £10bn of new money to buy bonds issued by private companies. While there are much better ways to boost the UK economy, today we give 10 reasons why Corporate QE won’t help boost the UK economy and could turn out to be a bad idea.
What is Corporate QE?
In response to the potential economic risks of the Brexit vote, last month the Bank of England announced that it would extend its £375bn QE programme by another £70bn.
The Bank will continue with its previous policy, by buying an extra £60bn of government debt. However, this time round it’s also trying something new, by buying £10bn of private sector debt from businesses that make a material contribution to the UK economy. Indeed, as of yesterday, the Bank will buy £555 million of corporate bonds over the course of the next 18 months.
While we will give a more detailed explanation of Corporate QE in our QE 101 blog series, for now, it is worth noting that there are three general aims to this part of the QE programme:
- Lower interest rates in financial markets, which should reduce the general cost of borrowing for private sector companies
- Lower interest rates also mean investors receive less when making conventionally safe investments, which should convince them to take on riskier investments with a higher rate of return
- Encourage corporate companies to issue more bonds (i.e. incentivise corporates to borrow more, to finance a higher level of investment)
10 Reasons Why Corporate QE is a bad idea
1) Firstly, as we have noted elsewhere, interest rates in corporate bond markets are already at an all-time historic low. This poses questions as to how much QE will be able to lower borrowing costs; and whether a minimal reduction in borrowing costs will actually translate into any noticeable increase in investment.
2) Further attempts to lower interest rates in the financial markets will hurt pensioners and savers. Lowering the returns on traditionally safe investments (the logical investment for pension funds) is exacerbating the UK’s pension deficit problem. As pension funds receive less for their investments, they find it increasingly difficult to make good on the amount they have promised to pay out in terms of retirement plans.
3) Corporate QE will help to increase house prices. Instead of encouraging investors to take on more risk, Corporate QE will incentivise investors and savers to put the money into property. As demand for property goes up, and supply remains relatively fixed, house prices will rise.
4) As Adair Turner (former chairman of the FSA) has frequently pointed out, the UK is currently suffering from a ‘private debt overhang’. A lot of UK companies are already deeply indebted; so it’s not clear whether they will be incentivised to take on more debt. As the saying goes, “you can bring a horse to a well, but you cannot force it to drink”*.
5) There are a number of questions about how the Bank of England will select the corporate bonds it decides to purchase. While the Bank has suggested it will only purchase bonds issued by corporates that make a material contribution to economic activity in the UK, the list of eligible companies includes a considerable amount of foreign multinational companies, including the likes of Apple, Nestle, and McDonalds (see full list below). Whether these companies will boost investment in the UK as a result of the subsidies received from the Bank of England remains to be seen. Moreover, the extent to which the likes of American companies, such as Verizon Wireless and AT&T, make a material contribution to the UK economy is also questionable.
6) Since the bulk of Corporate QE is aimed at multinationals, it’s worth noting that globally, multinationals currently have amassed a £4.1 trillion mountain of cash reserves. There are significant questions as to whether corporates even need cheaper funding. Indeed, UK private non-financial companies are sitting on a £1.8 trillion war chest of assets, £0.5 trillion of which is believed to be cash. This whopping amount of money is sitting idly not being invested and suggests that corporates are hardly in need of cheaper funding.
7) The primary reason that many corporates are sitting on such a huge amount of cash is because they are pessimistic about future economic conditions. This begs the question as to whether corporates will even want to borrow more, given economic uncertainty about the future (and any potential uncertainty that arises from the Brexit process).
8) There is also less incentive for corporates to begin issuing a significant number of new bonds – they may not want to borrow in sterling, compared to dollars or euros. Evidence gathered by Dealogic suggests that there is £285bn sterling investment-grade bonds versus £1.3tn denominated in euros and £4tn denominated in dollars. As many of the listed corporates are multinationals, they have substantial costs in foreign currencies – many corporates don’t actually need sterling other than to pay wages and salaries.
9) As in the USA, lower borrowing costs might just prompt more financial engineering – in the form of share buy-backs – that won’t trigger any new investment in the economy. Many corporates are expected to take advantage of the lower borrowing costs and issue more debt, merely to buy back their own shares. By buying back their own shares, they will boost the share price as well as shareholder profits. This form of financial engineering will trap money in the financial markets, and will not lead to any of the much-needed investment that will boost productivity, incomes, and jobs.
10) There is a much a better way – the Bank of England could create money for people, not financial markets. Instead of creating new money in an attempt to manipulate interest rates in financial markets, the Bank can make money available to be given directly to ordinary people (i.e. to pay down their debts and for spending), or use it to finance green infrastructure projects or affordable house building.
For these reasons (and many others) Positive Money is launching a petition to get Chancellor Phillip Hammond to abandon the current QE programme in favour of alternatives which don’t have the same negative side-effects (please sign here).
* There might be good reasons to believe that Corporate QE will initially lure business to borrow more – as some recent evidence suggests. But the ECB’s Corporate QE programme has a similar initial effect (€50bn was sold in March), but as the FT reports: “supply has since waned and the bond buying is yet to spur either capital investment or even bond sales to fund dividend payments, stock buybacks or mergers.”
List of companies eligible for BoE bond-buying scheme:
BG Energy Capital
CIE De Saint-Gobain
Daily Mail & General Trust
Electricite De France (EDF)
Electricity North West
Great Rolling Stock
Manchester Airports Group
Northern Ireland Electricity
Severn Trent Water
UK Power Networks
South East Water
Tate & Lyle
Transport for London
Wales & West Utilities
Western Power Distribution