The Bank of England is considering negative interest rates – would that be welcome?

by Tom Bailey from Money Observer |

There is a growing chorus of voices arguing that negative interest rates have been harmful to those countries that have tried them.

For the first time in its history, the Bank of England is reviewing the prospect of setting its bank base rate below zero.

Speaking before the Treasury Select Committee, Andrew Bailey, the new governor of the Bank, said that negative rates were under review.

Bailey had previously ruled out negative interest rates, following comments from the Bank’s chief economist Andy Haldane that such measures were under consideration.

However, Bailey told the committee yesterday (20 May) that while he is still not “planning or contemplating” negative rates, he has “changed his position a bit” and that the policy is under “active review”.

The increased prospect of negative interest rates also comes after the UK government auctioned bonds on a negative yield for the first time. As Richard Carter, head of fixed interest research at Quilter Cheviot, notes: “The sale of a three-year government bond at negative interest rates was an historic moment and demonstrated the ongoing demand for UK gilts despite increased issuance.”

Carter says that this will also fuel the debate over whether the Bank will eventually adopt negative interest rates. He notes: “Recent comments by MPC members suggest they are keeping their options open and could ‘go negative’ if the economy flatlines during the second half of 2020.”

Doing so would see the UK join Japan, the eurozone, Switzerland and Denmark, all of which currently have negative rates. Sweden previously had negative rates but, citing concern about their long-term economic impact, reversed course last year.

The purpose of negative interest rates is to encourage banks to lend more and consumers to borrow more, stimulating economic growth. The Bank’s base rate already stands at a historically low 0.1%, so any further meaningful cut would take that into negative territory.

However, before savers rush to withdraw their savings and place them under their mattress, it should be noted that for the most part negative rates have not been passed on to consumers where they have already been tried. Understandably, banks are reluctant to start docking the accounts of their savings customers.

The most prominent example of negative rates being passed on to customers has been more welcome: in August 2019 the Danish bank Jyske Bank introduced a 10-year fixed-rate mortgage at -0.5%. This means that while the borrower still must make repayments every month, the total they will pay is less than initially borrowed.

However, with banks reluctant to pass on the cost of negative rates to their customers, the policy often ends up acting as a tax on banks. By harming the profitability of the banking sector, economic growth itself can take a toll.

Indeed, there are a growing number of voices who argue that negative interest rates have been harmful to those countries that have tried them.

On top of harming the profitability of the banking sector, negative rates help sustain the so-called zombie economy - companies that have been able to survive only thanks to low or non-existent borrowing costs. This potentially harms growth due to the opportunity cost of having capital and labour tied up in underperforming firms.

Added to that, negative rates encourage more risk-taking by financial markets. Negative interest rates mean even lower (or negative) yields for bonds.

This, in turn, depresses yields on reliable dividend-paying companies (so-called bond proxies), as investors “reach for yield". As a result, investors find themselves having to look in even riskier corners of the market for income.

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

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