Super-sizing the Bank’s asset purchase programme: what is to be gained from buying McDonald’s corporate bonds?
Nadya Mihaylova - 27 October
As part of its strategy to revive the economy following the EU referendum, the Bank of England committed to purchase £10bn worth of corporate bonds in companies which were believed to deliver ‘material contributions to the UK economy’ – either through providing significant employment opportunities, generating large revenues or having a sizable customer base in the UK. The intuition behind the move was to push down borrowing costs and encourage more long-term capital investment and job growth. It was also aimed to lower the cost of issuing Sterling debt directly and narrow the spreads investors demand to compensate them for buying bonds with higher default risk.
The list of selected companies which met the eligibility criteria has already unleashed a wave of criticism. While the biggest beneficiaries are utility firms with significant operations in the UK, foreign based companies previously accused of tax avoidance (such as Apple and McDonalds) are also included. To add to the confusion, the corporate bond shopping basket also includes two British tobacco giants, raising complex issues around socially responsible investment. There is also the argument that smaller companies would benefit proportionately more from the Bank’s support as very cheap credit was amply available already to the highest quality investment grade issuers prior to the policy announcement.
While this policy instrument works in theory, a major criticism is that it is impossible for the central bank to trace how borrowed funds are used or to ensure that these are invested for the benefit of the real economy. Given the steady increase in asset prices, it is reasonable to assume that a large proportion of the funding has been reinvested into equity markets and distributed as dividend payments, rather than committed to projects with proven benefit to the domestic economy. Moreover, given the loose monetary policy conditions across the developed world, there is limited evidence that companies are currently struggling to find affordable credit. Other fundamental factors, linked to consumer confidence and uncertainty about the economic outlook, could play a bigger role in their decision-making processes.
While a corporate policy purchase programme in the teeth of the financial crisis would have made sense when there was a lock-down in market activity and premiums were significantly higher, it has slender justification today. Speculation that the BoE could expand its asset purchasing programme and include corporate bonds triggered a surge in the amount of issuance even before it was officially announced and led to a higher supply of bonds compared to the amount available from the central bank. While compressed yields stimulate more borrowing and benefit existing bond holders, it also discourages investors from seeking to purchase them. Given that the UK corporate bond market is relatively small, the entrance of a dominant player, in the shape of the central bank, could create serious price distortions in the market and have an adverse liquidity impact. The Bank has opened another can of worms, not another can of Pepsi.
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