BOE Rate Cut Puts U.K. Banks Between A Rock And A Hard Place

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Includes: BCS, CS, DB
by: Kal Telage

Summary

BOE action underscores real concerns over Brexit.

The stimulus package puts pressure on U.K. and European banks.

Banks respond by slimming down on assets.

One expectation is higher corporate and government bond prices and much lower yields.

Courtesy of the Author

Last Thursday, the BOE cut interest rates from 0.5 to .25. This is the lowest interest rate in the Bank's 322-year history. Correspondingly, it revived a financial crisis-era bond buying program, including government and corporate bonds, as part of a broad stimulus package to stimulate the U.K. economy in the wake of Brexit.

In a news conference, BOE Governor Mark Carney explained:

By acting early and comprehensively, the MPC can reduce uncertainty, bolster confidence, blunt the slowdown, and support the necessary adjustments in the U.K. economy. The stimulus package, which included a torrent of cheap cash for banks, underscores the concern at the BOE following the June 23 referendum.

Projections Predict Negative Consequences

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Courtesy of the Author

Price Inflation, GDP Growth, Unemployment Rate

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Courtesy of the Author

Ramping Up The Pressure

The BOE interest rate cut ramps up pressure on U.K. bank profits, spurring cost-cutting initiatives. Big European banks have begun slimming down by cutting on Wall Street assets as new U.S. rules kick in.

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Courtesy of the Author

Barclays PLC (NYSE:BCS) reduced assets at its U.S. brokerage, Barclay Capital, by 43%.

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Courtesy of the Author

Assets of Deutsche Bank (NYSE:DB) securities were down 30%, while Credit Suisse Group AG's (NYSE:CS) brokerage shrank by 26%.

European banks are now engaged in a process of catching up to U.S. banks that adopted stricter regulations subsequent to the 2008 financial crisis. One consequence is that U.S. banks are now in a position to take share from Europeans.

"It's of interest to note that the BOE isn't stress-testing U.S. banks operating in the U.K. even though U.K. firms are subject to U.S. stress tests."

Conclusion

Expect corporations to engage in financial engineering, issuing large amounts of debt for nothing. They can do the same with dividends. They can buy back stock. The current demand created by banks is insatiable, but it has to stop at some point.

U.S. and U.K. government bonds will strengthen by reducing the amount of bonds available (supply) and increasing (demand). Bond prices rise and bond yields fall.

This only reinforces that central banks are still far into easing mode.

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