Anemic FLS lending, but consumer confidence surges

Usage and lending data for the Funding for Lending (FLS) Extension showed that net lending significantly decreased in Q1 14 relative to previous quarters. After healthy readings during H2 13, Q1 data are somewhat disappointing (Figure 1).

Participants drew £2.0bn under the scheme, bringing the cumulative drawdown to date to £43.3bn. Net lending by participants was -£2.7bn, and mainly attributable to negative net lending to large companies. Lending to SMEs also declined, coming in at -£0.7bn in Q1.

In terms of sectors, according to the Bank of England, the biggest decline was concentrated in lending to businesses in the real estate sector, which could partially reflect banks’ efforts to reduce non-performing loans to the commercial real estate sector. However, this effort is likely to have been ongoing since after the crisis, and, thus, does not have much explanatory power for Q1’s results.

We believe that the FLS’s success in lending to businesses has been limited so far. While some of the weakness in total lending reflects a shift from banks to other sources of financing for large corporates, SMEs are more dependent on bank loans.

Bank of England Credit Conditions Survey for Q1 revealed that even though the balances of availability of credit and demand for credit (in the past three months) for businesses have been positive, availability of credit to medium private non-financial corporations (PFNCs) has failed to keep up (Figure 2).

As noted by our credit strategists, banks in the UK (and Europe) appear to be capital-, not liquidity-, constrained, thus, it is unlikely that credit to SMEs will expand substantially, until regulatory uncertainty surrounding CRDIV and the ECB’s AQR has receded.

In this regard, one could argue that a scheme that provides relief on capital constraints, rather than liquidity, could be more successful in boosting overall bank lending when capital requirements are a binding constraint. Although difficult to infer causality, the pickup in lending in mid-2013 is associated not only with the ongoing FLS, overall lower bank funding costs in markets at home and abroad, improved economic outlook, but also with the start of the Help to Buy (equity loan) government scheme.

The performance of the FLS in the UK is particularly relevant to recent discussions on ECB interventions to increase credit flows, especially to SMEs.

As higher capital requirements are as important a constraint to bank lending as liquidity, targeted liquidity measures taken by the ECB (along with interest rates cuts) may struggle to gain traction until completion of the comprehensive assessment, amid weak supply and weak demand.

Higher consumer confidence and improved economic outlook are likely to support consumption strength in Q2

Consumer confidence increased again in May, reaching zero and getting out of negative territory for the first time in nine years. The headline index rose to 0 from -3 in April, coming in slightly higher than our above-consensus expectation of -1. Improvements were broad-based, with the ‘general economic situation over the last 12 months’ improving the most, up 8 points to -5.

This month’s positive outcome resonates with ongoing improvements in the economic outlook for consumers and supports consumption growth in Q2. If sustained, strong job creation, the improving property market, improving real earnings, and higher confidence are likely to be an impetus to strong consumption in Q2.

We expect household consumption in Q2 to continue growing at a similar pace as in Q1, and recording 2.2% y/y growth in 2014. We also forecast GDP to grow 0.7% q/q every quarter in 2014, consistent with y/y growth of 3.0%.