Negative space: The BoE considers taking rates below zero
19 Nov 2020
The Bank of England (BoE) has already implemented unprecedented stimulus measures to counter the economic effects of the pandemic. The BoE has cut its key interest rate close to zero, increased its purchases of assets to keep longer-term borrowing costs in check, and expanded a programme to supply low-cost loans to commercial banks. But as COVID-19 cases continue to mount, threatening the economic outlook, that may not be enough.
In the latest ‘3 Point Perspective,’ our Research team examines the prospects of the BoE emulating other major central banks by implementing some form of Negative Interest Rate Policy (NIRP). Evidence from the euro area, Japan and elsewhere indicates that such a move could provide a real boost to the UK economy, if deployed as part of a broad package of easing measures.
NIRP is on the table – and may be needed if the outlook worsens
In August, the BoE opened the door to negative rates, discussing how low rates could go before they reached their “effective lower bound” – or the point at which further cuts do more harm than good. In October, the BoE took another step closer, writing to regulated banks to ask about their readiness to deal with rate of zero or below. The current policy rate – 0.1 percent – is already the lowest in the BoE’s 325-year history.
Markets have responded. Futures markets are pricing in some possibility of negative policy rates, while yields on Treasury bills and longer-term bonds have dropped.
The BoE kept its base rate unchanged at its monetary policy meeting in November, while adding to its asset purchases. Our Research analysts believe that any serious deterioration in the UK’s economic outlook – exacerbated by uncertainty over Brexit – could prompt the BoE to press ahead with a new round of monetary stimulus, including negative rates.
NIRP has costs, as well as benefits
The Danish National Bank cut rates to below zero in 2012, as did the European Central Bank in 2014, the Swedish Riksbank and the Swiss National Bank in 2015, and the Bank of Japan in 2016. The evidence from these experiences suggests that there is a real short-term hit to banks’ profits, because yields on their assets – mortgages, personal loans and so on – tend to fall faster than their cost of funds.
Policy rates have turned negative in various countries
Source: ECB, Dansmarks Nationalbank, Sveriges Riksbank, BoJ, Haver Analytics, Barclays Research
But over time, that squeeze on banks’ margins can be offset by loan growth and lower loan losses, consistent with a healthier economy. Further, banks have ways to compensate for the drag on profits, such as by charging big companies and wealthy customers for deposits.
Meanwhile, the economic benefits of negative rates tend to take effect more broadly. Borrowing costs drop for companies and households, while negligible rates on deposits encourage people to spend today rather than save for tomorrow. If there is a serious downside, our research suggests it is in the area of financial stability, as ultra-low rates encourage investors to pile into ever-riskier assets in search of yield.
NIRP works best when deployed in combination with other monetary or fiscal tools
If the BoE pulls the trigger on negative interest rates, it is likely to be in response to a scenario in which unemployment rises and inflation drifts further away from the Bank’s two percent target. It is also likely to be part of a package of measures, perhaps involving pledges to keep rates as low as possible for a long period of time, and a relaxation of capital standards applied to banks. Such combinations have proven effective overseas.
In view of the hit to banks’ profits, one solution would be for the BoE to cut the policy rate to zero while making a much bigger cut in the rate charged to banks through the Term Funding Scheme, a special low-cost loans programme. Reducing that rate to minus 0.5 percent, for example, from the current rate of around 0.1 percent, could cut banks’ overall cost of funding, making them more willing lenders to companies and households.
UK recovery forecasts have adjusted down
Source: Bank of England, Haver Analytics, Barclays Research
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Fabrice Montagné is Chief UK Economist at Barclays. Previously, he was a senior European economist responsible for French, Greek and euro area macroeconomics. Mr. Montagné joined Barclays in January 2012 from the Dutch Central Bank where he was responsible for balance sheet, asset/liability management and strategic asset allocation decisions in the Financial Market division. Prior to that, he worked at the French Treasury and Fonds de Reserves pour les Retraites. Mr. Montagné graduated from Ecole Polytechnique, has an MSc in Economics and Statistics from ENSAE, and an MSc in Economic Analysis and Policy from the Paris School of Economics.
Abbas Khan is an analyst in the macro research group at Barclays, with a focus on UK economics. He is based in London and joined the firm in July 2019 as a graduate. Mr. Khan holds a BA in Classics from the University of Cambridge (Gonville and Caius college).