The Bank of England's plan to free up Britain's home loan market by injecting 50 billion pounds into the banking sector to ease the mortgage squeeze has come under scrutiny from the EU.
Bank of England Governor Mervyn King hopes to inspire confidence in the economy
The bank's 50-billion-pound (62.3 billion euros, $100 billion) plan is being studied by the EU as to whether it constitutes state aid, a European Commission spokesman said Monday, April 21.
"We are in touch with the UK authorities concerning this scheme and it is far too early to start speculating about whether it is state aid or not," said Jonathan Todd, spokesman for the EU's top competition regulator.
The Bank of England's plan is designed to allow high street banks to swap mortgage-backed securities for government bonds to try to boost liquidity at a time when banks are hesitant to lend to each other.
The intervention followed a meeting of Britain's top bankers with Prime Minister Gordon Brown last week, at which the emergency measures were discussed. "We will make sure that there is enough liquidity in the economy so that we can continue to lend money for businesses and lend money for people to buy their own houses," Brown later said.
A statement from the Bank of England's said that the scheme aimed to improve the liquidity position of the banking system and increase confidence in financial markets, which have been hit by the shockwave emanating from the US economic slowdown and the subsequent global financial turbulence.
The plan is also designed to tackle an estimated overhang of 35 billion pounds of debt in the 1.2 trillion pounds UK mortgage market that banks would have repackaged and sold on, had the credit crisis not hit.
"Financial markets are not working normally, which if left unchecked will have an impact on the wider economy. Across the world, there is a lack of confidence in assets created from packages of bank loans, most notably mortgage-backed securities," the Bank of England statement said.
Cash injection could increase with demand
The initial amount of 50 billion pounds could increase depending on the amount other banks need to get lending going again and how much they're willing to provide in costly collateral. "There is no arbitrary limit on it," Bank of England Governor Mervyn King told reporters when asked about the cash injection.
"It's not part of this scheme to take us back to the excessive lending of a year or more ago," King added. "It's to return the banking system back to a state of normality."
The US subprime crisis led to UK lenders tightening their belts
Britain's main home loan providers are rapidly tightening their lending criteria as fears persist over the sector's exposure to the collapsed subprime or high-risk housing market in the United States.
Central banks around the world have been taking a variety of actions to get the frozen markets moving. The Bank of England's plan is one of the biggest moves yet by a major central bank to combat the global credit crunch. The US Federal Reserve last month unveiled a $200 billion scheme to help its own mortgage markets.
The Bank of England's plan was revealed at the same time as reports claiming the Royal Bank of Scotland was seeking some 10 billion pounds in a new rights issue to shareholders this week. The bank, Britain's second-largest, is also expected to reveal further write-downs, probably in the region of 5 billion pounds.
No quick fix, say analysts
Despite the positive noises being made by the banks in regard to the Bank of England's plan, analysts are less convinced that it would be enough to revive a flagging economy.
The Bank of England plan will not fix the financial crisis
"It will have a positive impact on the money market but it's unlikely that it will have any meaningful impact on unlocking mortgage markets," one economist told Reuters.
"This is not going to undo the harm that's already been done to the economy," said another. "It might just stop things getting any worse."
The International Monetary Fund (IMF) took a different view. According to Michael Deppler, director of the IMF's European Department, the global credit crisis and persistent gloom over the US economy is continuing to have a detrimental effect on the outlook for European economic growth.
IMF forecasts negative effects in Europe
"Europe has so far been relatively resilient to the US slowdown and the global financial turbulence, but the historical record suggests these will increasingly take their toll," he said in a statement.
Gross domestic product (GDP) across Europe is expected to take a significant hit this year due to the combination of the fallout from the credit crisis, the near-record strength of the euro and soaring food and energy prices.
The IMF stated that "growth rates in the advanced economies are projected to fall well below potential for some time" and forecasted that Europe's GDP would fall from last year's figure of 3.9 percent to 2.6 percent this year.
Last week, Germany's key economic institutes revised down their growth outlook for Europe's biggest economy, forecasting that German economic growth will come in at 1.8 percent in 2008 before slowing to 1.4 percent in 2009. The eight institutes had previously forecast growth at 2.2 percent for this year.