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Tuesday, May 28, 2024

    UK Central Bank Contemplates Negative Interest Rates

    UK Central Bank Contemplates Negative Interest Rates: When the Bank of England governor says he is not ruling out a cut in the cost of borrowing to below zero, you know there is trouble ahead.

    Negative interest rates are the last resort of the central banker and not to be used unless absolutely necessary. At least that is the thinking inside the forbidding walls of the Bank’s offices on Threadneedle Street.

    Only a couple of weeks ago, governor Andrew Bailey said, in effect, that the Bank had never lowered interest rates to below zero and wasn’t going to start now.

    With the Bank rate standing at 0.1%, it seemed odd to make a distinction between a moderately positive rate of interest and a moderately negative one.

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    But in the world of central banking, such posturing appears alive and well. Only those economies considered weak and feeble go negative. Not the UK.

    Of course, there was more substance to Bailey’s argument than that. Like his predecessors, he argued that negative rates would put a huge strain on high street banks, which would see their profit margins on lending squeezed.

    Tighter margins would lead them to accept households and businesses with only the safest credit histories, meaning fewer loans would be granted. Rather than being expansionary, negative rates would lead to a contraction in borrowing the opposite of what the central bank wanted to achieve.

    Last week he changed his tune and argued it would be “foolish” to rule out such a move. For many economists, Bailey was recognising the magnitude of the current downturn. And, theoretically, there are ways to keep high street lenders safe from harm.

    Negative rates allow the borrower to pay back less at the end of the term than originally borrowed. Borrowing becomes very attractive, and nervous households that might not have taken a loan to buy a car or new kitchen might go ahead with credit this cheap.

    If a high street lender can borrow at an even lower negative rate from the central bank, there should be scope to maintain profit margins and stay profitable.

    The problem lies with savers who are offered negative interest on their savings. What happens if they refuse to accept this new reality? They will take their deposits out of the banks and find another home for them.

    Gold is the usual safe haven from negative interest rates, but middle-income families are unlikely to start buying bars of the stuff or even derivatives of gold that allow punters to buy and sell more easily. Cryptocurrencies on the other hand – long seen as an esoteric and volatile form of money – could take off even more than they have already with mainstream savers.

    And, deprived of deposits, the high street lenders will then lack the reserves they need to lend, defeating the object of the exercise.

    In Japan, the central bank has told high street banks not to worry about deposits and other usual safeguards; it has said it will act as the backstop for the entire financial system.

    The European Central Bank has tried to mimic this stance and been held back from such a wholehearted approach only by the reluctance of Germany, Austria and the Netherlands, which fear underwriting the shaky financial systems of their southern European neighbours.

    Bailey’s gloomier outlook for the UK one that expects a shallower recession but several years of business bankruptcies, higher unemployment and lower investment could see the UK follow the Danes, who have sanctioned the high street lender Jyske Bank’s plan to offer negative-rate mortgages.

    A poll of City economists found that the majority believe the unintended consequences of negative rates in an economy the size of Britain’s will deter the central bank from pulling that particular lever.

    Let’s hope the final assessment sets aside any notion of national pride and focuses on the real-world consequences. Britain is going to need all the support it can get from its central bank in the next few years.


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