Bond financing conditions and economic activity in the UK: aggregate and firm-level evidence

Eduardo Maqui, Nicholas Vause and Márcia Silva-Pereira

In recent decades, the corporate bond market has grown from a relatively niche source of finance for UK corporations to a central pillar alongside bank loans. This transition raises an important question: as with bank credit conditions, have supply conditions in the corporate bond market come to significantly affect UK economic activity? Our recent research suggests the answer is a resounding yes. We show that a measure of corporate bond financing conditions − the Excess Bond Premium (EBP) − not only anticipates macroeconomic outturns in the UK, but also influences investment by UK firms, especially those that are highly leveraged and more reliant on bond finance.

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High hurdles: evidence on corporate investment hurdle rates in the UK

Krishan Shah, Phil Bunn and Marko Melolinna

An important way in which monetary policy impacts the economy is through its effects on the capital expenditure of firms. When policy rates are raised (and as long as risk-premia remain unchanged) firms’ cost of capital increases. A higher cost of capital should lead firms to increase their required return (or hurdle rate) on investment, resulting in fewer projects exceeding the hurdle rate and less investment overall. For monetary policy to impact investment, changes in the cost of capital need to pass through to hurdle rates. Using new survey evidence, we find that hurdle rates for UK firms tend to be high, and they have responded sluggishly to higher interest rates over the past two years.

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Another reason to care about investment taxes

Alex Kontoghiorghes

Do lower taxes lead to higher stock prices? Do companies consider tax rates when deciding on their dividend pay-outs and whether to issue new capital? If you’re thinking ‘yes’, you might be surprised to know that there was little real-world evidence (let alone UK-based evidence) which finds a strong link between personal investment tax rates on the one hand, and stock prices and the financial decisions of companies on the other. In this post, I summarise the findings from a recent study which shows that capital gains and dividend taxes do indeed have big effects on risk-adjusted equity returns, as well as the dividend, capital structure, and real investment decisions of companies.

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Risk perceptions and economic activity in the United Kingdom

Nicholas Vause and Carolin Pflueger

Recently, Pflueger, Siriwardane and Sunderam (2020) proposed a new measure of investor risk perceptions based on the cross-section of stock prices. Using that measure, they found that when risk perceptions are high, the cost of capital of risky firms is high and subsequently real investment and employment decline in the United States. In this post, we show that similar relationships exist in the United Kingdom. In 2023 Q1, the UK measure fell to its lowest level since the outbreak of the Covid pandemic, indicating higher risk perceptions and potentially foreshadowing weaker economic activity. This indicator may be helpful for policymakers, as it could serve as a useful measure of risk perceptions relevant for future economic developments and monetary policy.

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Debt and investment: what can we learn from SMEs’ investment behaviour during and after the Global Financial Crisis?

Mai Daher and Christiane Kneer

Many UK firms weathered the Covid shock by taking on debt. Small and medium-sized enterprises (SMEs) in particular borrowed at an unprecedented rate and their debt increased by around a quarter since end-2019. But debt that allowed SMEs to survive the pandemic could now hamper the recovery as indebted firms may struggle to invest and grow. Debt on SMEs’ balance sheets could also make firms more vulnerable to future shocks and could amplify downturns if indebted firms reduce investment more following shocks. To understand how investment might evolve, our recent FS paper examines how leverage affected SME investment during and after the Global Financial Crisis (GFC) and discusses potential differences given regulatory and other changes since the GFC.

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Monetary policy, sectoral comovement and the credit channel

Federico Di Pace and Christoph Görtz

There is ample evidence that a monetary policy tightening triggers a decline in consumer price inflation and a simultaneous contraction in investment and consumption (eg Erceg and Levin (2006) and Monacelli (2009)). However, in a standard two-sector New Keynesian model, consumption falls while investment increases in response to a monetary policy tightening. In a new paper, we propose a solution to this problem, known as the ‘comovement puzzle’. Guided by new empirical evidence on the relevance of frictions in credit provision, we show that adding these frictions to the standard model resolves the comovement puzzle. This has important policy implications because the degree of comovement between consumption and investment matters for the effectiveness of monetary policy.

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Housing consumption and investment: evidence from the Help to Buy scheme

Matteo Benetton, Philippe Bracke, João F Cocco and Nicola Garbarino

Academics have made the case for mortgage products with equity features, so that gains and losses due to fluctuations in house values are shared between the household and an outside investor. In theory, the equity component expands the set of affordable properties, without increasing household debt, and default risk. These products have not become mainstream, but in a recent paper, we study a large UK experiment with equity-based housing finance — the Help To Buy Equity Loan scheme. We find that equity loans are mainly used to overcome credit constraints, rather than to reduce investment risk. Unconstrained household prefer mortgage debt over equity loans, suggesting optimism about house price risk. Equity loans could still contribute to house price inflation: we don’t find evidence that houses purchased with equity loans are overpriced, but an assessment of the aggregate effects is beyond the scope of the paper.

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Tight labour markets and self-service beer: is the productivity slowdown about to reverse?

Will Holman and Tim Pike

Firms are increasingly investing in automation, substituting capital for labour, as workers become more scarce and costly. We are seeing multiple examples, from automation in food processing to increasingly-common self-service tills. This push for productivity growth is one of the key themes from our meetings with businesses in the past year, which we think suggests a reversal of a decade-long trend.

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Home grown financing: How small business owners use their own houses to support investment

Saleem Bahaj, Angus Foulis and Gabor Pinter

Apocalypse Now is widely regarded as a masterpiece of the new Hollywood era. Director Francis Ford Coppola displayed audacious vision and a willingness to take risks. But we don’t just mean artistic risk. Mr Coppola gambled financially too: he staked his Napa Valley house and vineyard on the film, pledging it order to get the $32 million in loans necessary to keep the production on the road. While his movie was exceptional, there is nothing unusual about Mr Coppola’s financial strategy. Small business owners worldwide use their personal assets, and often their house, to back loans to their firms: in a new paper, we use microdata for several thousand firms to show how important this can be for UK investment.

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Is finance a powerful driver of growth?

Saleem Bahaj, Iren Levina and Jumana Saleheen.

Since the financial crisis the UK has experienced a period of weak productivity growth, weak investment coupled with a decline in credit to non-financial sectors of the economy. But there is debate about the direction of causality: did low growth and other structural factors mean firms and households wanted to borrow less – as argued by Martin Wolf? Or did the financial sector offer too few funds to the real economy in the wake of the crisis as banks tried to repair their balance sheets. Alternatively, the financial system may not be functioning properly in general, if much of the financial sector’s activity contributes little to the betterment of lives and efficiency of business – a point made by John Kay.

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