Hot debate that negative rates will shrink commercial banks’ margins, making them more reluctant to extend loans

Bloomberg business magazine is reporting that the Bank of England (BOE) is preparing to take a significant step into the debate on whether negative interest rates should be used to stimulate the coronavirus-stricken United Kingdom (UK) economy.

The BOE is slated to publish this week the results of 160 detailed responses to ongoing consultation about how borrowing costs could be pushed below zero. If implemented, this would be the first time since England’s Central Bank was founded in 1694 that it would be introducing negative interest rates.

This controversial policy of negative interest rates, which has already been tried in the European Union and Japan, would see banks charging for deposits while paying those who borrow money. There are concerns that negative rates will shrink commercial banks’ margins, making them more reluctant to extend loans at the moment when the economy needs it most.

Bloomberg argues that Europe’s half-decade experiment with the policy has put pressure on revenue and burdened lenders with penalties for parking cash with the Central Bank. Negative rates may also distort the traditional dynamics of borrowing and lending, with some wealth managers charging their clients for deposits.

Negative interest rates already weighing heavily on BOE Governor

This hotly contested policy position of negative interest rates, according to Bloomberg, is already weighing heavily on BOE Governor Andrew Bailey, who is trying to pull the UK out of its worst slump in three centuries.

Bailey faces the daunting task of trying to keep the cost of debt low enough to spur a recovery against the concerns raised by the local banking sector that such monetary experiments would result in the closure of businesses and damage the financial system.

However, leading economists in the UK expects the BOE to embrace negative rates as a tool but stop short of implementing them for now.

Elizabeth Martins, senior economist at HSBC Holdings Plc., told Bloomberg she did no believe the market would be told that negative rates are imminent.

However, she said, ruling it out “might result in higher effective market rates, which could impede the bank’s goal to restore growth”.

A decision from the BOE’s Monetary Policy Committee is due on February 4, along with the bank’s quarterly forecast.

The report is likely to highlight the challenges of going below zero – a further signal that such a move is far from imminent. Most economists surveyed last week expect the key rate to remain at or above the current 0.1 per cent through the middle of 2023. 

Only one bank in the survey expected below-zero rates at any point. Based on this survey, economists at Goldman Sachs reportedly wrote in a note to clients, dated January 31: which stated: “We therefore expect the MPC to indicate that it sees a moderately negative effective lower bound and that further rate cuts are feasible, even though a bank rate cut was not judged to be appropriate at this time.”

Economists report that the threat of negative rates along with the BOE’s bond-buying plan has the effect of anchoring the cost of money in financial markets – a maneuver that directly benefits the government. Investors on the other hand are more aggressive in pricing in negative rates, but they currently don’t see them arriving for at least a year.

Cheap borrowing is helpful to Chancellor of the Exchequer Rishi Sunak, who Bloomberg says has spent about £300 billion so far supporting the economy, a splurge that pushed government debt to a record. This support was executed to help businesses and workers forced off the job by COVID-19 restrictions, especially those in the hospitality and leisure sectors.