GOVERNMENT ANNOUNCES THIRD STRAND OF ECONOMIC RECOVERY

UNCLAS SECTION 01 OF 02 LONDON 000187

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: GOVERNMENT ANNOUNCES THIRD STRAND OF ECONOMIC RECOVERY
PACKAGE

REF: 08 State 134459

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1. (U) HMG announced new measures to reinforce financial stability
and ensure the resumption of lending on January 19. To improve
banks' access to wholesale funding markets, HMG will provide full or
partial guarantees to eligible AAA-rated asset backed securities
from April. Additionally, HMG will extend the drawdown window of
its existing credit guarantee scheme from April 9 to December 31.
To address the loss of mortgage lending capacity, HMG said Northern
Rock will no longer need to actively pursue a policy of rapidly
reducing its mortgage book to repay its government debt. To
increase the availability of corporate credit, the Bank of England
will establish an asset purchase scheme, authorized by HMT, to buy
up to GBP 50 billion high quality private sector assets, financed by
the issue of Treasury bills. (Note: HMT said this facility could be
used by the Bank's Monetary Policy Committee as a way to meet its
inflation target of two percent - potentially paving the way for
quantitative easing. End note.) To reduce banks' uncertainty about
the value of past investments, HMG will offer capital and asset
protection on assets most affected by economic conditions (details
of this measure are expected in February). To provide banks with
access to long-term liquidity, the Bank of England will extend its
Discount Window Facility, increasing the length of time assets can
be swapped for from 30 days to one year. Finally, HMT said in the
longer term, it will work with the FSA to incorporate
counter-cyclical measures into capital ratio requirements, requiring
banks to build up buffers in good years that they can draw on during
economic downturns.


2. (U) Prime Minister Gordon Brown said the measures focus on
helping British banks struggling to fill a gap in credit provision
left by the retreat of foreign and non-bank lenders. He said the
package was the third part of HMG's strategy following last year's
bank recapitalization program and subsequent fiscal stimulus
measures. He stressed the importance of working in partnership with
other countries facing the same problems and preventing a "damaging
de-globalization" and return to protectionism. Chancellor Darling
told MPs the measures would remove uncertainty and accelerate the
resumption of lending, a necessary precondition for recovery.

Package Has "Reasonable Chance" Of Success
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3. (U) HMG's package has a "reasonable chance" of unblocking the
flow of credit within the banking system and capital markets,
according to Paul Tucker, Executive Director of Markets at the Bank
of England. Tucker told MPs of the Treasury Committee that there
are no silver bullets, but that he believes it is a good package.
He said the asset purchase scheme, whereby the Bank will have the
authority to purchase high quality corporate bonds, does not
immediately amount to quantitative easing. However, he did not
totally reject suggestions that this might happen soon. He warned
MPs that the UK package needs to be accompanied by similar packages
internationally if it is to succeed. Tucker, soon to be responsible
for financial stability at the Bank, supported HMG's fiscal stimulus
but said it is vital that the government make a credible commitment
to get the public finances on a sustainable footing. Mervyn King,
Governor of the Bank of England, showed support for HMG's package
during a speech in Nottingham. He said asset purchases can increase
the supply of money and credit, thereby increasing spending. He
warned, however, that there is a fine line between helping to oil
the wheels in markets which are temporarily impaired, and
artificially supporting markets in which there is no underlying
demand. Therefore, the Bank will need to be satisfied that there is
genuine demand for the asset in normal conditions before it is
eligible for the asset purchase facility. King also noted that such
purchases involve taking more credit risk onto the public sector
balance sheet.


4. (U) HMG's measures will be critical to increasing lending to the
economy, according to the British Bankers' Association. The Council
of Mortgage Lenders welcomed the broad thrust of the package,
particularly the guarantee scheme for asset-backed securities which,
it believes, will help restart the securitization market. If the
measures are fully implemented, they should stem a downward
recessionary spiral and provide a stable economic platform,
according to the Confederation of British Industry, which welcomed
HMG's bold response to the economic downturn. It welcomed the
"extra extraordinary" policy solutions and said they are essential
pre-cursors for economic stability, which will expand the
availability of credit, open new channels of credit and get the
economy working.

Market Reaction
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5. (U) The market and public reaction to the latest set of
government initiatives suggest there is no confidence that HMG's

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policies are working, according to Conservative Party Leader David
Cameron. Cameron's comment during the Prime Minister's Questions,
January 21, alluded to the reaction of bank shares following the
Chancellor's announcement on January 19: Barclays' share price fell
17 percent; Lloyds Banking Group fell by almost a third; and RBS
closed down 67 percent. (Note: These large declines are also
attributable to rumors of further nationalizations in the banking
sector. End note.) Sterling fell to its lowest level against the
U.S. dollar in more than five years, hit a record low against the
yen and fell against the euro following the announcement. This
weakening is partially explained by fears that the rescue package
will substantially increase the UK's debt beyond the 8 percent of
GDP projected by the Chancellor in his Pre-Budget report.

TUTTLE