Pay­ing to save

Neg­a­tive in­ter­est rates are no panacea – but they may be in­evitable

The Daily Telegraph - Business - - Front Page - Tom Steven­son

When Andrew Bai­ley stepped up to be­come Gov­er­nor of the Bank of Eng­land six months ago, he was em­phatic about the prospect of neg­a­tive in­ter­est rates in Bri­tain. “On the whole, neg­a­tive in­ter­est rates, no … it is not an area I would want to go to.”

Fast for­ward to last week’s rate­set­ting meet­ing on Thread­nee­dle Street and the odds of a base rate be­low zero look shorter. The mon­e­tary pol­icy com­mit­tee has been briefed on how neg­a­tive rates could work in prac­tice and what steps could be taken to min­imise the most dam­ag­ing side­ef­fects. The drop in the value of the pound said it all. It looks like when, not if, we fol­low Europe and Ja­pan be­low the zero bound, maybe not this year but prob­a­bly in 2021.

The dif­fer­ence be­tween March and Septem­ber can be mea­sured on three fronts: Covid-19 looks no bet­ter than it did in the spring if spec­u­la­tion about a half-term lock­down is any­thing to go by; the econ­omy is look­ing into the abyss of a post-fur­lough em­ploy­ment cri­sis; mean­while, a no-deal Brexit ap­pears close to in­evitable come Jan­uary.

This un­palat­able cock­tail makes it likely that Bri­tain will pip Amer­ica to the post when it comes to neg­a­tive rates, but the Fed­eral Re­serve is also one small step away from cross­ing the in­ter­est Ru­bi­con. Jay Pow­ell last week kicked the next up­turn in rates even fur­ther into the long grass, to the end of 2023 at least. Don­ald Trump, if he is re­turned as pres­i­dent in Novem­ber, will keep bang­ing his Twit­ter drum for the “GIFT of neg­a­tive rates”.

If we do go down that path, we at least have the ad­van­tage of hav­ing seen how the ex­per­i­ment has worked out across the chan­nel since rates fell be­low zero in Europe in 2014 and Ja­pan two years later. Over­all, things have turned out a bit bet­ter than the neg­a­tive rate scep­tics sug­gested they might. Bank lend­ing picked up in Europe and un­em­ploy­ment fell. The re­gion’s de­fla­tion­ary spi­ral was ar­rested. The sale of safes may have briefly risen, but savers didn’t stuff cash un­der the mat­tress. A re­duc­tion in bad loans helped banks off­set the squeeze on mar­gins that low rates, pos­i­tive or neg­a­tive, im­ply.

Swe­den may have called time on its five-year dal­liance with neg­a­tive rates, but the ECB’s hope that go­ing be­low zero would show it had not run out of am­mu­ni­tion has, so far, been jus­ti­fied.

There are, nonethe­less, plenty of good rea­sons not to like neg­a­tive rates. In the US, there is firstly the con­sid­er­a­tion that they might not even be le­gal. A 2006 law that al­lows the Fed to pay in­ter­est to banks talks about de­pos­i­tors “re­ceiv­ing earn­ings” and doesn’t even men­tion the pos­si­bil­ity of levy­ing a charge in­stead. The US also has around $4trn tied up in money mar­ket funds, short-term debts that many in­vestors treat as a proxy for a cash de­posit ac­count. Not get­ting your cap­i­tal back in full, “break­ing the buck” in the jargon, came close to caus­ing a panic in 2008 dur­ing the fi­nan­cial cri­sis.

But the main prob­lem with neg­a­tive rates is that there is scant ev­i­dence that they ac­tu­ally work in the way in­tended, by boost­ing con­fi­dence and in­creas­ing eco­nomic ac­tiv­ity. One rea­son for this is that there ap­pears to be a so-called “re­ver­sal” rate of in­ter­est be­low which peo­ple are not en­cour­aged to bor­row and spend more but are in­stead spooked into pre­cau­tion­ary sav­ings. Some econ­o­mists ar­gue that very low or neg­a­tive in­ter­est rates lead to low in­fla­tion, be­cause they en­cour­age the self-ful­fill­ing ex­pec­ta­tion that prices will fall.

A fur­ther rea­son to be cau­tious is that there is a limit on the ex­tent to which banks can pass on neg­a­tive rates to their cus­tomers. Most will not pass on a penalty in­ter­est charge. At the same time, the amount they can charge on loans is re­duced. Their prof­its are squeezed, and they con­se­quently re­duce the amount of avail­able credit at pre­cisely the time when the econ­omy needs it to be in­creased.

One last ar­gu­ment not to go down the neg­a­tive rates path is the im­pact it could have on al­ready dam­ag­ing lev­els of in­equal­ity as “free” money finds its way into as­set mar­kets, hous­ing in par­tic­u­lar. Den­mark has in­tro­duced mort­gages that re­duce the amount of cap­i­tal owed by a small amount each month. Low rates un­avoid­ably en­cour­age ex­ces­sive risk-tak­ing.

The im­pli­ca­tions for other in­vest­ments are also largely untested. Given the need for bond yields to of­fer in­vestors a yield pre­mium, how­ever small, over cash, there might be a prac­ti­cal down­side limit to long bond yields and so an up­side limit to their price. This might make them in­ef­fec­tive as a hedge against the volatil­ity of shares. The im­pact on the dol­lar might, con­trary to ex­pec­ta­tions, be to in­crease its safe-haven value. At the very least, it might en­cour­age in­vestors into riskier or more illiq­uid as­sets in their des­per­ate search for yield. It cer­tainly makes banks a less at­trac­tive in­vest­ment, threat­en­ing the sta­bil­ity of the fi­nan­cial sys­tem.

So, neg­a­tive in­ter­est rates are no panacea. But as we move closer towards a cash­less so­ci­ety, the con­straints on cen­tral banks em­ploy­ing this last throw of the mon­e­tary dice are re­duced. There is a kind of in­evitabil­ity about them, I think, un­less politi­cians ac­cept the role that gov­ern­ment spend­ing must play in a bet­ter-bal­anced sup­port op­er­a­tion.

It is eas­ier with fis­cal pol­icy to tar­get those who most need the stim­u­lus and are more likely to spend it rather than sim­ply en­joy the pos­i­tive im­pact it has on their wealth.

‘The main prob­lem with neg­a­tive rates is that there is scant ev­i­dence that they ac­tu­ally work in the way in­tended’

Tom Steven­son is an in­vest­ment di­rec­tor at Fidelity In­ter­na­tional. The views are his own. He tweets at @tom­steven­son63

Andrew Bai­ley, the Bank of Eng­land Gov­er­nor, could yet change his mind on neg­a­tive in­ter­est rates

Newspapers in English

Newspapers from UK

© PressReader. All rights reserved.