Global developments and domestic financial conditions

1.1 Global economic developments

There was a broad-based slowing in global GDP growth over 2018 across advanced and emerging market economies (Chart 1.1). UK-weighted world GDP growth appears to have stabilised in 2019 Q1, with quarterly growth expected to have increased to 0.6% (Table 1.A), higher than projected at the time of the February Report. US GDP growth picked up to 0.8% in 2019 Q1, euro-area growth rose to 0.4%, while growth in China was 1.4%.

The slowdown in global growth in part reflects a tightening in financial conditions during 2017–18, as asset prices adjusted to tighter policy, especially in the US and China. It may also reflect the imposition of trade barriers, such as tariffs on trade between the US and China, which may have contributed to weaker business confidence and a slowdown in world trade growth (Chart 1.2). In advanced economies, the slowdown in growth has been concentrated in investment and net trade (Chart 1.3).

Higher-frequency indicators suggest that UK-weighted global GDP growth will be around 0.5% in 2019 Q2. Global manufacturing and export order PMIs stabilised in 2019 Q1, having fallen over 2018, for example.

Against the backdrop of weak data, there has been a shift in the policy outlook in some major economies, with monetary policy in particular now expected to be looser than previously expected (Chart 1.4).

In the euro area, the European Central Bank (ECB) announced that policy rates are expected to remain at present levels at least until the end of 2019, longer than stated in its guidance at the time of the February Report. To help support bank lending conditions and the smooth transmission of monetary policy, the ECB also announced further two-year targeted longer-term refinancing operations, to be offered from 2019 Q3 to 2021 Q1. The market path for policy rates in the euro area slopes upwards, but gently.

In the US, the Federal Open Market Committee made no changes to its target range for the federal funds rate in March. But the path of policy rates implied by market prices has declined further over the past three months and is markedly lower than in November. It is now downward sloping, suggesting that market participants view a cut in the policy rate as more likely than an increase in coming years. The Committee also announced an end to the reduction in its balance sheet by September 2019.

In China, the authorities announced further fiscal measures to support activity, including significant cuts in taxes and increases in infrastructure expenditure. The latest fiscal measures, alongside a previous easing in monetary and credit policies, should provide support to demand.

Lower expectations for the path of policy rates have contributed to a rise in global risky asset prices, reversing weakness at the end of 2018. Equity prices internationally have risen since February (Chart 1.5) — the S&P 500 had its strongest quarter for almost 10 years for example — and corporate bond spreads have narrowed further (Chart 1.6). As a result, global financial conditions have loosened since February.

Financial market-based measures of investor uncertainty, such as the VIX measure of implied equity price volatility, have fallen back to below historical averages. Other measures of uncertainty paint a different picture, however. The Baker, Bloom and Davis index of global policy uncertainty, which includes media references to uncertainty and other indicators such as the dispersion of professional forecasts, remains elevated (Chart 1.7).

In the MPC’s central projection, the easing in global financial conditions, as well as previously announced tariff increases on US-China trade not being implemented, are expected to provide support to global growth. Four-quarter UK-weighted GDP growth is expected to trough in Q2 before recovering somewhat in 2019 H2 and settling around trend rates. The projection is a little higher than at the time of the February Report.

1.2 Domestic financial conditions

As in other countries, UK short and longer-term interest rates have fallen and equity prices have risen since February. Credit conditions facing corporates have loosened a little as corporate bond spreads have narrowed, while those facing households have remained generally favourable. Sterling has appreciated a little.

Market interest rates and sterling

The market-implied path of Bank Rate over the next three years is, on average, around 15 basis points lower than in February, and is now expected to reach around 1.0% in three years’ time (Chart 1.4). Longer-term UK interest rates are also lower: the yield on 10-year UK government bonds has declined to 1.2% from 1.3%. Combined with the moves in the run-up to the February Report, both short and long-term interest rates have fallen by around 40 basis points since November.

The sterling ERI has been sensitive to Brexit developments. It has appreciated by 1½% since the February Report, which market contacts attribute to a lower probability being attached to a no-deal Brexit. The sterling ERI remains around 15% below its November 2015 peak (Chart 1.8).

Following the extension to the negotiation period for the UK’s withdrawal from the EU, sterling implied volatilities — an indicator of uncertainty around the outlook for the exchange rate — fell sharply. And the cost of insuring against a large depreciation relative to a large appreciation also fell, as market participants appear to be pricing in a lower probability of a sharp fall in sterling over the next six months.

Credit conditions facing companies and households

Over the past few years, credit conditions facing companies have been relatively accommodative. However, conditions in corporate bond markets — which large companies use to borrow — deteriorated at the end of 2018. Bond spreads across the main markets in which UK companies borrow widened markedly (Chart 1.6). These spreads have since narrowed, driven by the same factors that eased financial conditions globally (Section 1.1). UK corporate bond issuance has resumed, although it remained below its historical average in 2019 Q1 with most issuance concentrated among investment-grade companies.

According to the Credit Conditions Survey, the availability of bank credit to companies has been little changed in recent quarters. However, reports from the Bank’s Agents suggest that the availability of credit has tightened for sectors that may be more exposed to Brexit, such as export-focused firms.

The Credit Conditions Survey indicates that the demand for corporate credit has remained subdued. Respondents to the Survey did, however, report an increase in the demand for inventory finance in Q1 and almost two thirds of respondents to the Lloyds Business Barometer survey in March reported that they were prepared for Brexit-related pressures on working capital. Supervisory intelligence suggests that, as yet, the banks accounting for the majority of lending to corporates have not reduced their willingness to provide working capital finance. The majority of respondents to the Agents’ recent survey also reported no change in the availability and cost of working capital or trade finance in the past three months (Box 5).

Credit conditions facing households have generally remained favourable. Mortgage rates have been stable at low levels, despite large moves in spreads on banks’ unsecured wholesale debt over the past six months. Box 2 discusses recent developments in mortgage rates.

There is some evidence of a tightening in household credit conditions in parts of the unsecured lending market. While personal loan rates remain low (Table 1.C), respondents to the Credit Conditions Survey reported that the availability of unsecured credit tightened further in 2019 Q1. In the credit card market, interest-free periods on purchases and balance transfers have continued to fall; the maximum 0% balance transfer period has fallen to below 30 months for the first time since 2013. That tightening in credit supply is likely to have accounted for some of the slowing in consumer credit growth over 2018.

Box 2 Recent developments in new mortgage rates

Over the period since the financial crisis, the average interest rate on new mortgages has fallen markedly reaching a low of just under 2% in October 2017. Since then, Bank Rate has risen by 50 basis points but the average rate on new mortgages has increased by less (Chart A). As a result, the difference between new mortgage rates and risk-free rates — the mortgage spread — has fallen further.

One factor that is likely to have weighed on new mortgage rates, potentially offsetting the upward impetus from Bank Rate, is competition in the mortgage market. Discussions with lenders suggest that competition has been intense for some time. Since the start of 2018 this is most apparent in the high loan to value (LTV) segment of the mortgage market: the average quoted rate on two-year fixed 95% LTV mortgages has fallen by around 80 basis points despite reference rates having picked up slightly (Chart B).

Competition in the mortgage market may have been amplified by the ring-fencing of major UK banks which separates retail banking services from other activities.¹ As some ring-fenced entities have more domestic deposits than loans, and are subject to restrictions on the type of banking activity they can undertake, they may be incentivised to increase mortgage lending.

Lending rates will also be affected by developments in banks’ funding costs. While the cost of bank funding raised in wholesale markets has fluctuated substantially in recent months, those movements have not been transmitted to mortgage rates. As discussed in Box 1 of the February Report, the importance of wholesale unsecured funding spreads in loan pricing is likely to have fallen as the large retail banks increased their share of deposit funding, particularly sight deposits, relative to wholesale funding. Indeed, the value of banks’ deposits now exceeds that of their loans, and supervisory intelligence indicates that banks take into account deposit rates when pricing loans.

Given those developments, the stability of deposit rates over the past few years (Chart A) may help explain the stability of mortgage rates. Prior to 2008, sight deposit rates were some way below Bank Rate. When Bank Rate was cut to very low levels during the financial crisis, deposit rates fell by less and the spread between them became positive. Retail banks’ desire to return this spread towards more normal levels may help explain why deposit rates, and therefore mortgage rates, have not risen one-for-one with Bank Rate recently.²

In the MPC’s projection, mortgage rates are expected to pick up gradually over the forecast period partly because spreads on new mortgage lending over risk-free rates widen a little. There is uncertainty around that judgement, however, as it will depend on how factors such as competitive pressures and deposit rates evolve. The MPC will continue to monitor the dynamics in the mortgage market, as well as its implications for the monetary transmission mechanism more broadly.

• Notes

  ¹ For more information see Britton, K, Dawkes, L, Debbage, S and Idris, T (2016), ‘Ring-fencing: what is it and how will it affect banks and their customers?’, Bank of England Quarterly Bulletin, 2016 Q4.

  ² See Saunders, M (2019), ‘Pass-through of Bank Rate to household interest rates’.