The Bank of England is preparing to take a significant step into the debate on whether negative interest rates should be used to stimulate the coronavirus-stricken U.K. economy.
The central bank this week is due to publish the results of 160 detailed responses to a consultation about how borrowing costs could be pushed below zero for the first time since it was founded in 1694. The controversial policy, already tried in the European Union and Japan, turns banking on its head by charging for deposits while paying those who borrow money.
It’s a political hot potato for Governor Andrew Bailey, who is weighing how to pull the U.K. out of its worst slump in three centuries. It puts the desires of policy makers to keep the cost of debt low enough to spur a recovery against the concerns of banks, which say monetary experiments are upending business and damaging the financial system. Economists expect the BOE to embrace negative rates as a tool but stop short of implementing them for now.
“I don’t think they will tell the market negative rates are imminent,” said Elizabeth Martins, senior economist at HSBC Holdings Plc. But ruling it out “might result in higher effective market rates, which could impede the bank’s goal to restore growth.”
A decision on monetary policy is due on Feb. 4 along with the bank’s quarterly forecast. Most economists surveyed last week expect the key rate to remain at or above the current 0.1% through the middle of 2023. Only one bank in the survey expected below-zero rates at any point.
That would leave the BOE’s asset purchase program as the key tool for stimulating the economy. The bank currently targets quantitative easing of 895 billion pounds ($1.2 trillion) — money it uses to buy bonds, ensuring yields remain low.
The threat of negative rates along with the BOE’s bond-buying plan has the effect of anchoring the cost of money in financial markets — a maneuver that directly benefits the government. Investors are more aggressive in pricing in negative rates, but they currently don’t see them arriving for at least a year.
“They won’t do it, but they also won’t stop the bluff,” said Mark Nash, head of fixed income alternatives at Jupiter Asset Management.
Cheap borrowing is helpful to Chancellor of the Exchequer Rishi Sunak, who has spent about 300 billion pound so far supporting the economy, a splurge that pushed government debt to a record. It’s paying to help businesses and workers forced off the job by Covid-19 restrictions, especially those in the hospitality and leisure sectors.
“The report is likely to highlight the challenges of going below zero — a further signal that such a move is far from imminent.”
It’s not clear that the U.K. needs more help from the BOE now. The economy grew more strongly than expected during a lockdown in November, which Bailey said is an indication that businesses are adapting to the restrictions. Chief Economist Andy Haldane expects a sharp rebound in the second quarter as Prime Minister Boris Johnson’s vaccination program takes hold.
There are concerns that negative rates will shrink commercial banks’ margins, making them more reluctant to extend loans at the moment when the economy needs it most. Europe’s half-decade experiment with the policy has put pressure on revenue and burdened lenders with penalties for parking cash with the central bank. Negative rates may also distort the traditional dynamics of borrowing and lending, with some wealth managers charging their clients for deposits.
“In the long run, negative rates ruin the financial system,” Deutsche Bank AG Chief Executive Officer Christian Sewing said in 2019.
At the BOE, the math of the nine-member Monetary Policy Committee is stacked against a big shift for now. Internal members, who hold the majority, have appeared more skeptical toward sub-zero rates. The four voters who don’t work for the central bank full time have said they might be effective.
Whatever the BOE says this week about negative rates, it’s likely that many of those responding will highlight their objections.
It’s “terrible idea” said James Athey, senior investment manager at Aberdeen Standard Investments. The policy “reduces productive capacity, thus lowering growth and requiring more monetary easing to offset it — a self-fulfilling and self-defeating cycle.”