SHOULD THE UK TRY A NEGATIVE INTEREST RATE?
Back in the mists of time, there was a Bank of England Governor who maintained a firm stance against taking interest rates below zero. “As things stand, I do not regard negative official interest rates as a plausible tool,” he said. That distant era was March, the Governor was Andrew Bailey, and the world has changed since.
Now the Bank is reviewing its “effective lower bound” (ELB), the point below which rates cannot usefully fall, and we could get an update tomorrow. That ELB stands at just 0.1pc, so any change could open the door to negative rates.
Proponents say negative rates could help to get the economy back on its feet. But do they work?
Five major central banks have gone sub-zero so far, and the evidence indicates very mixed results.
Japan took short-term rates to minus 0.1pc in 2016 and seeks to keep long-term market rates down too.
The idea is to promote borrowing, spending and investment. It has certainly boosted asset prices. In the real economy inflation remains well short of the 2pc target, though it is no longer near deflation. Growth has not accelerated since the policy began.
“Japan has run fiscal deficits for decades now, all funded at low or recently negative interest rates,” say analysts at Citi. “Rather than escaping from secular stagnation, they seem more mired in it than ever.”
The European Central Bank took its deposit rate negative in 2014, initially to minus 0.1pc and now to minus 0.5pc. The ECB says it lifted the supply of credit. Along with QE it has helped indebted states stay on top of finances.
But its experience also shows the difficulties of using negative rates, which hit banks’ margins, potentially impeding lending instead of raising it. As a result the ECB “tiers” the negative rate, only applying to a portion of banks’ deposits. Yet this erodes a main incentive to lend more. When Sweden’s Riksbank took its deposit rate negative in 2014, it expected inflation to return to target in one year. Instead it took almost five to get close and the rate was returned to zero last December.
It feared the perception of permanently negative rates would lead to negative rates on savings.
“The minus world has not had a full impact on households, as the deposit rates they meet have not passed zero,” said deputy governor Henry Ohlsson.
“This has, on the one hand, meant that the impact of monetary policy has been less than in the plus world.
“But on the other hand, it has probably also meant that households have not been as upset as they would otherwise have been.”
In Denmark, however, housebuyers can repay less on mortgages than they borrowed. Some savings accounts charge a sub-zero rate to those with more than about £85,000. Yet savings levels have not fallen, suggesting customers may hoard cash when central banks take radical steps.
With a rate of minus 0.75pc, passed on to depositors with big balances plus institutions’ deposits, odd things happened in Switzerland.
Customers have sought out safety deposit boxes instead of savings accounts, paying a fee to stash 1,000 franc (£825) notes in a locker instead of incurring negative rates.
It messes with cash flow plans, too. The canton of Zug used to offer a discount for early payment of taxes. In 2016 it cancelled the scheme and asked for payments to come in later instead to avoid incurring negative rate losses.
Former Bank of England policymaker Charles Goodhart warns that keeping rates low for the longterm risks building up debts, creating “zombie” firms, delivering lower economic growth through the poor allocation of credit, and weaker banks through the erosion of their profits.
Sven Jari Stehn, at Goldman Sachs, thinks the Bank will lower its ELB simply to have the option on the table – thus pinning down market rates.
That would let Bailey reinforce low rates without having to risk the consequences of going through the looking glass into sub-zero conditions.