Will the Bank of England cut rates below zero?

The summer boom has faded since the Bank of England last met and the resurgent second wave of the pandemic has dented the economic outlook. We may get another dose of QE but the Bank is unlikely to rock the boat by imposing negative interest rates just yet given the state of flux in the pandemic and the economy.

However they are clearly warming markets up for the possibility, having written to banks to check they can handle rates going below zero. Somewhat counterintuitively, they are likely to wait until economic conditions have improved a little because if banks are worried about loan losses mounting up at the same time their interest income is cut they may just curtail lending. That would be counterproductive from the central bank’s point of view.

Experience of negative rates in other countries suggests that even if rates turn negative, most banks wouldn’t charge high street customers to hold money in their accounts, mainly because you can always take cash out of the bank and stuff it in a mattress. Those with higher balances would be most at risk because a bank account provides security that is hard to replicate without financial cost. While savers might not explicitly pay interest to their bank, it’s possible banks would introduce fees instead, something HSBC said it’s looking at in some markets.

Savers have stuck away £88 billion so far into cash this year, as those who have been lucky enough to maintain their jobs and income have found their spending options cut down by covid restrictions. Much of that money is losing value in real terms and will continue to do so if the Bank is successful in bringing inflation up towards 2%. They should be helped in this endeavour by the big fall in the oil price dropping out of the inflationary equation from next March.*

Looser monetary policy will be broadly good for equities, and for the growth stocks that have led the market for the last ten years. Corporate borrowing will be even cheaper and while pension deficits may rise, these only have an effect on cashflows through a valuation process that takes place every three years.

We can expect bond prices to nudge up too but that means yields will fall further, another blow to anyone relying on fixed interest securities for income. It will be good for the government however as it will lower its borrowing costs further.

Indeed on the gilts held by the Quantitative Easing programme, the government effectively pays bank base rate on that borrowing. To date that has resulted in a £99 billion windfall for the Exchequer.**

If base rate falls to zero, this could mean the government paying no interest rates on the gilts held by the QE programme. That’s right- free money! If base rate goes negative, the central bank may take steps to limit payments back to the Treasury at the zero bound. But we’re so far through the looking glass when it comes to monetary policy, we could end up in a position where Treasury is actually making money from the gilts held as part of the QE programme.

Indeed, the UK government is already paying negative interest rates on some of its debt – earlier this year it auctioned £3.8 billion of borrowing on which buyers agreed to pay the government 0.003% for the privilege of lending money to HM Treasury.***

Economic indicators

Sources: ONS, IHS Markit, www.gov.uk
* seven day average

Internet searches for "negative interest rates" at a peak

UK Google searches for negative interest rates are now at a peak. But the UK wouldn’t be the first country to experiment with interest rates below zero. The Danish National Bank cut rates to below zero in 2012, as did the ECB in 2014, the Swedish Riksbank and the Swiss National Bank in 2015 and the Bank of Japan in 2016.

Negative interest rates winners and losers

Winners

• The government – we can expect gilt yields to fall even further, reducing government borrowing costs. Plus the government would pay no interest from the gilts held in QE, or may possibly receive interest itself.
• The stock market – asset prices will be pushed up by more liquidity in the system, lower borrowing costs, and the fact return-seeking investors have nowhere else to go. Financial stocks would suffer though (see below).
• Borrowers – mortgage rates should fall.
• Exporters – a lower pound should make UK goods and services cheaper on international markets.
• Bond investors – prices should rise.
• Gold – priced in dollars so in theory should appreciate for UK investors, but it’s been behaving very strangely of late.

Losers

• Savers – another cut. Add it to the pile that’s been growing over the last decade, unlike cash in the bank.
• Income-seekers – bond yields will fall, and that will also push down the yield on other assets paying an income, like pension annuities and dividend-paying stocks.
• The pound - would likely fall if rates were cut again.
• Importers – would therefore see a rise in the cost of goods.
• Financial stocks - banks and insurance companies would find their profit margins squeezed.

*Source is Bank of England http://www.bankofengland.co.uk/boeapps/iadb/fromshowcolumns.asp?Travel=NIxSSxSCxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=1963&TD=3&TM=Nov&TY=2020&VFD=Y&html.x=9&html.y=25&CSVF=TT&C=H5&Filter=N

**Source is also Bank of England https://www.bankofengland.co.uk/-/media/boe/files/asset-purchase-facility/2020/annual-report-2020.pdf

***Source FT https://www.ft.com/content/3d576f71-6833-4a55-8b8c-f4abfb0ca172

These articles are for information purposes only and are not a personal recommendation or advice.