Yesterday even the mainstream media woke up when something I have been discussing on here for nearly two years flashed up on their radar. The specific occurance was when Deputy Governor of the Bank of England Paul Tucker mentioned negative interest rates. Actually the accident prone Mr.Tucker -remember his gaffes in the Libor scandal- did not mean what most have taken from that mention and his announcement that not only would it be a “radical idea” but also the following.
This would be an extraordinary thing to do and it needs to be thought through very carefully
As you can see he was giving the impression that something really significant would happen here. Whereas he was specifically discussing a technical move between the Bank of England and banks. Oh dear another mistake as we again review how such a gaffe prone individual has ended up with an index-linked pension worth around £5 million.
Is the Bank of England about to introduce negative interest rates?
The latest minutes of the Monetary Policy Committee suggest that Paul Tucker’s idea was rejected. Indeed he did not even vote for a move in this direction himself,perhaps he forgot?
The Governor invited the Committee to vote on the propositions that:
Bank Rate should be maintained at 0.5%;
Regarding Bank Rate, the Committee voted unanimously in favour of the proposition.
Actually there are a row of issues here. Firstly there are two 0.25% cuts available to the MPC before it would push official interest rates negative. So you might think that Paul Tucker might vote for them before his “radical idea”! Also none of his colleagues seem keen. This matter has come up many times with the initial rejections a couple of years ago being based on fears of what damage would be done to the banking system and believe it or believe it not whether computers there would be able to cope! If we step back in time to then there was a Cheltenham and Gloucester mortgage which for a period of four years tracked the base rate less 0.54% if I recall correctly so borrowers were owed money albeit small amounts.
Even now the MPC has concerns on this issue as illustrated by the quote from the latest minutes below.
These included: purchases of other assets; a reduction in Bank Rate; and changing the marginal rate of remuneration on banks’reserves at the Bank of England. The Committee had noted drawbacks with each of these options in the past; those drawbacks remained. The Committee would nevertheless continue to examine all of the policies potentially available to it.
So not keen on them (for now) including what Paul Tucker really meant to say. Amazing isn’t it how often people regularly described as intelligent are unable to articulate what is not that complex an issue? As they often do not appear to be intelligent to me that word went into my financial lexicon for these times a while back.
What did he mean?
Let me explain. Right now banks hold money with the Bank of England for various reasons but one of them is the security provided in what are very uncertain times and in return for this the receive the base rate which is currently 0.5%. Paul Tucker suggestion would be to cut this to discourage them from doing so and the logical step actually might be to cut it to zero. However the European Central Bank has done this and it made no real difference as banks continued to deposit money with it although slightly bizarrely they did change accounts which confused some.
So Mr.Tucker has realised that negative interest rates might be required here but I wonder if he has considered how negative? The ECB evidence above suggests that banks might be as hard to shift as barnacles on a boat and they might require a fairly heavy dose of negative interest rates. Also they could simply pass the costs on to their borrowers and savers which would mean that Paul Tucker would have scored yet another own goal.
If we return to the plan which Paul Tucker hopes would take place is that he would force banks to take money away from the Bank of England and they would then lend it on. The fundamental problem which this ignores is that banks right now are unwilling to lend as otherwise they would be doing so on a larger scale and that this measure does not address this. Indeed what if they treat this as an increase in their costs and simply keep the money at the Bank of England and raise their borrowing rates to get the money back? After all every policy intiative so far has ended up improving and not reducing bank profitability.
What about savers?
Here we have a difficult conceptual issue as whilst there is scope for savings rates to be reduced as they are around 2% there are problems here too. For the economy as a whole the contractionary effect of reducing savings rates has been much stronger than the Bank of England expected and in my view has been one of the reasons their policy has not worked. So further reductions would have this contractionary effect before we get to the issue of how you make savers accept an interest rate of below zero. There is plainly a large danger that they would withdraw their money from the banks at this point.
Such deposit withdrawal would pose quite a few questions. Firstly official policy -unless they have forgotten- is for banks to have more not less retail deposits as a way of avoiding the problems that befell Northern Rock. Ooops! Also if it led to savers hoarding cash via banks notes there are plenty of dangers here such as theft and fire.
You might think that reducing borrowing rates should that actually happen, rather than the possible rises discussed above, would lead to more borrowing. Except that so far such moves have led to borrowers being much more prone to deleveraging or paying off borrowing rather than borrowing more. This has no doubt been influenced by the lack of willingness of our banks to lend. So the lending boost if the evidence so far is any guide would be likely to be very weak if it existed at all.
Actually in real terms we do have negative interest rates
If we subtract the rate of inflation from official interest-rates then they are already substantially negative. For example with the official Consumer Price Inflation measure being at 2.7% that leaves us with a -2.2% rate and the Retail Price Index at 3.3% means that it is -2.8% on this measure.
So as you can see Paul Tucker did not actually mean negative interest rates for the whole system. As we examine the possibility we yet again see the possibility and maybe probability that it would increase borrowing rates whilst doing nothing for the volume of bank lending. There are also plainly issues for savers.
Such a move would be likely to spread into other interest-rates including the base rate as the Bank of England appears to be forever looking for new ways to loosen monetary policy. Whilst I think it is a bad idea I have been afraid for some time that the UK might get negative official interest-rates. As they trawl through, talking down the exchange rate of the pound, more Quantitative Easing, and other schemes such as the Funding for Lending Scheme and they continue to fail then under my “More,More,More” theme in a combination of desperation and panic they could cut interest-rates further and send them negative.
What they would be ignoring by so doing is that if cutting the base rate by 4.5% from 5% to 0.5% has had so little effect what exactly they expect to happen if they continue on this road?
For those listening to this I was/am Shaun from Battersea as I thought that as it is a specialist topic I had expertise to offer about negative interest rates. Indeed there was some impact as I note that James O’Brien changed his introduction to reflect what I had told them. Unfortunately however as I explained the consequences for savers he went “Thanks Shaun” and cut me off as this was unwelcome for his weight lifting analogy!
You can but try………