Negative interest rates – a plot to ease QE fears?

“I’m sorry Liam, we’re losing you,” said John Humphreys on BBC Radio 4’s Today programme last week. “Oh what a shame, we can’t hear him,” the grand inquisitor continued. “It’s a very bad line”.

Explaining the implications of “negative interest rates” on the UK’s most influential news bulletin is tough at the best of times. Doing so when the communication link between you and the studio drops out, making you incommunicado 15 seconds after you’ve started speaking, makes the task more difficult still.

I’d like to use this weekend’s column to relate what I would have said to Humphreys and his millions of listeners, but for the digital gremlins. After all, news that the Bank of England could soon introduce negative interest rates is an important development. Discussion of it seems to have been lost under analysis of the Eastleigh by-election, if not to the broadcasting ether.

Paul Tucker is Deputy Governor of the Bank of England. Among our most senior policymakers, he doesn’t talk off the cuff. So what are we to make of Tucker’s statement to the Treasury Select Committee last Tuesday that the UK “should consider” introducing negative interest rates? This sounds like Alice in Wonderland – “through the looking glass economics”. The notion that a bank or building society, far from paying interest, should actually receive money on firms’ and households’ deposits, on top of bank charges, sounds absurd. But that’s not what Tucker was describing.

When banks deposit money at the Bank of England, they’re paid the minimum lending rate or “bank rate” set by the Monetary Policy Committee. That’s been at 0.5pc since March 2009, a three-century low. When economists advocate “negative interest rates” they’re arguing that banks, rather than receiving interest when depositing cash at their central bank, should instead be charged a fee. The idea is to encourage banks to lend out more funds, so boosting growth, rather than building an excessive and unproductive cash mountain at the central bank.

Tucker acknowledged that such a policy, while avoiding the lunacy of banks taking interest from savers, would still be “extraordinary”. That’s why it “needs to be thought through carefully,” he told some rather astonished MPs. Even without much thinking, it’s obvious this idea has serious drawbacks. While savings rates wouldn’t be formally affected, savers would still suffer.

If banks forego income on reserves, having to pay instead, those losses would almost certainly be recouped through even lower savings rates and, possibly, higher bank charges too. Having already seen interest payments hammered since the start of the financial crisis, and now enduring currency debasement too, savers would likely see rates squeezed even more.

The Bank of England’s most recent policy innovation – the Funding for Lending Scheme (FLS), which since last summer has offered banks up to £60bn of loans at rock bottom rates, provided they’re lent on to households and small firms – has already harmed those who’ve saved prudently. By making banks even less dependent on deposits, FLS has put additional downward pressure on savings rates, especially in recent weeks.

Quantitative easing has also seriously undermined savings income, of course, especially for pensioners. By pushing up gilt prices, and lowering the annuity rates dictating how much a new retiree receives annually, QE has cut some pensioners’ incomes for the rest of their lives.

For some years, rock-bottom base rates and stubbornly high inflation have seen savers young and old enduring interest rates that, in real terms, are already negative. If Tucker’s idea gathers momentum, on top of the existing savings woe, such “returns” will become even more negative still.

That’s why the Bank of England retreated soon after the Deputy Governor had spoken. The following day, fellow Deputy Governor Charlie Bean described Tucker’s comments as “blue-sky thinking”, before adding that “any suggestion we have a plan to introduce negative interest rates immediately, I should make absolutely clear, is not the case”.

This entirely inconclusive answer brings me to the gist of what I’d wanted to say to John Humphreys, before technical problems cut me off. Sweden broke the “negative interest rate” taboo in 2009, becoming the first country explicitly to charge on central bank deposits. Soon after, Mervyn King indicated the UK could follow suit. “It’s an idea we’ll certainly be looking at,” said the Bank of England governor.

While Tucker’s statement has been presented as mould-breaking, the Bank has said this before. The important point is that after Sir Mervyn’s words four years ago, gilt yields fell and sterling weakened. That’s precisely what happened after Tucker’s “blue-sky” statement too.

A Swedish-style negative interest rate policy won’t happen in the UK. The banks are too powerful – and will make sure of that. The government still views it as useful, though, if the Bank of England floats the idea from time to time.

Amid rising concerns about negative real-terms returns on UK government debt, which push up yields, the prospect of negative rates helps to keep government borrowing costs low. At the same time, policymakers want a weaker pound, in the hope of making exports more competitive while (whisper it) debasing the value of the UK’s massive debts, not least those owed to foreigners. A bit of negative-interest-rate speculation can help with that too.

The minutes of the February MPC meeting showed the committee moving towards an expansion of QE from its current level of £375bn, with three of the nine members voting for more funny money, compared to one the month before. Yet concerns about QE are growing too. Even previously staunch supporters have lately warned we might be overdoing it. While American QE has so far amounted to 14pc of annual GDP, with the eurozone’s at 4pc, the Bank of England has made asset purchases (overwhelmingly gilts) out of money created ex nihilo to the tune of 26pc of our national income.

When it comes to monetary policy, the Western world is deep into uncharted territory – and the UK is by far the most “out there” of all. What about the impact on savings? What about QE driving up global food prices and provoking “currency wars”? What happens to the gilts market when the policy stops and won’t the shock be worse the longer it continues? How, above all, will this unprecedented policy be unwound?

These are unavoidable questions. Yet significant government spending cuts are too difficult. Genuine bank recapitalization – the kind that would truly re-boot credit markets and spark lending – involves too many awkward questions about bombed-out balance sheets that everyone wants to avoid. So QE, apparently, must go on.

“I remain open to more QE,” said Paul Tucker last week. “Nobody on the committee thinks QE has reached the end of the road and isn’t a useful instrument anymore”. When trying to dampen growing fears about QE, what better strategy than raising the prospect of even more radical strategies (such as negative interest rates, or Lord Turner’s “helicopter money”), allowing the resulting speculation to ease the gilt markets and the currency. Such policies can then be ruled-out, but not categorically – allow the trick to be performed again in the future.

Scarily unorthodox and unfamiliar measures are being floated in a bid to make existing yet still very radical policies like QE look reasonable. QE on the scale the UK has already pursued it is about as far from reasonable as it is possible to be. It looks increasingly likely, though, that we’re about to go further still.


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