Negative interest rates in the UK? All eyes on BoE’s November MPC meet

Summary

• The Bank of England has already slashed the interest rates by as much as 65 basis points in the present calendar year
• The BoE has recognised that the uncertainties among the businesses are still high with the intent to invest remaining “very weak”
• Recently, one of the policymakers of the Bank of England’s MPC has hinted at the implementation of negative interest rates
• A handful of countries have adopted a negative interest rate model. Some of them are Switzerland, Japan, Spain, Sweden and Denmark

Countries across the world are facing the dearth of economic activity since the lockdowns have been implemented due to the coronavirus pandemic. The economic activities have slowed down after business closures, suspension of services in sectors such as tourism and travel, manufacturing, aviation, sports and entertainment, automobiles, retail, real estate, hospitality, regional marketplaces and several other small-to-large scale enterprises of non-essential nature.

Owing to the business downturn, job losses and a steep reduction in regular income sources, fall in consumption of goods and services, the government, the central bank and other regulators have been continuously working on ways to pump up the economy and revive some of the ailing sectors.

Low-Interest Rates

A possibility of negative interest rates in the UK has been under the review of the Bank of England since the Covid-19 cases started spreading. The Bank of England has already slashed the interest rates in its special Monetary Policy Committee (MPC) meetings earlier this year by as much as 65 basis points in the present calendar year to 0.1% from 0.75% as seen until early-March.

In September 2020, the Bank of England’s MPC, looking at the economic and financial impact of Covid-19, voted unanimously to maintain the interest rate at 0.1%. The Bank of England, in its MPC meeting chaired by governor Andrew Bailey, highlighted that the outlook for the UK economy remains “unusually uncertain” as the cumulative impact of Covid-19 pandemic will dematerialise gradually, and a rise in unemployment is anticipated.

The central bank also noted that the domestic consumption has recovered at a stronger-than-expected pace and is continuing to bounce back. However, it expressed its concerns on the recent increase in Covid-19 cases in the country and stated that spike in cases would have a serious impact on economic activity.

As per the minutes of the latest review meeting, the BoE has said that the uncertainties across the UK are very high and the intent to invest remaining ‘very weak’. With the persisting downturn, the central bank can now think about the technicalities of adopting the negative interest rate regime.

Recently, one of the BoE policymakers has hinted that the negative interest rates could be a distinct possibility in the near future. If the interest rates are negative, the central bank charges for any deposits it holds on behalf of lenders (banks here). This encourages banks to lend money to businesses rather than deposit it.

According to reports, Silvana Tenreyro, External Member of the Bank of England's MPC, has spoken widely in favour of negative interest rates in the country.

Tenreyro has said that early implementation of the negative interest rate policy could help in alleviating the ongoing economic jinx and can catalyse the recovery process. Tenreyro, a guiding member of the nine-member MPC and a Professor of Economics at the London School of Economics, has claimed that the response from other countries with a negative interest rate regime has shown encouraging outcomes.

In September MPC, the BoE said it is exploring how a negative interest rate framework can be enforced effectively. However, Governor Andrew Bailey has not been so keen on negative interest rates which offer subsidised lending. The next review meeting is scheduled in November’s first week with the policy outcome expected on November 5, 2020.

Negative Interest Rate

The Bank of England lowers interest rates when it wants people to spend and invest more rather than they save. So, if the interest rates are below zero, it should have the same effect - spend more and save less. Usually, in a stiffened environment like the coronavirus pandemic, the central banks tend to decrease the key lending rates in order to make the credit facilities more affordable. A few countries, including Japan, Switzerland, and Denmark, have adopted the negative interest rate model.

The United Kingdom will become the third major country after Japan and Switzerland among the major economies of the world, if the BoE decides to introduce a negative interest rate regime.

Pros and Cons of Negative Interest Rates

• The negative interest rates will directly benefit the people and larger corporations in many ways as the cost of acquiring capital will reduce substantially.
• Cheaper access to credit facilities will lead to more money in the pockets of people, and this will result in increased consumption.
• There is a chance that people who are looking forward to avail credit facilities, term loans and other credit-linked services from the banks and financial services institutions will cheer the move as the component interest payments may shrink.
• Negative interest rates certainly imply that individuals who want a bank to keep their money safe as deposits will have to bear some definitive costs which are subject to respective banks.
• An accelerated shift in people’s psyche can be seen as a larger chunk of people would like to withdraw their deposits to avoid the extra charges and utilise the same for other investments such as stocks, mutual funds, privately-operated retirement savings plan and precious metals etc.
• The corporations, small-scale or a fully functional enterprise, will be able to raise funds on a much lower interest rate to boost their businesses.
• There will be a substantial rejig in the primary business models of the banking system as the banks will start charging a fee for the deposits and will be keen on lending the credit.
• Largely, the banks will shift their focus to borrowers from the people who are expected to deposit a sum as the Bank of England will charge a rate from the banks for any money parked with the former.

Dubious Road Ahead

The full-fledged recovery in demand will take time as the health, and financial stability-related concerns will continue to weigh on the economy. The number of people accessing their respective retirement funds is likely to dictate the foreseeable future as the unemployment rate is likely to swing upwards as the government has already passed a resolution to reduce the furloughed workers, the Job Support Scheme.

The limitation of the latest scheme, which only covers the viable jobs, has already caused a disturbance amid a number of people who are enjoying the perks of the Furlough Scheme. As per the administrative data, around 700,000 paid workers have lost their jobs between February and August.

According to the central bank, the path of growth is dependent on the evolution of the coronavirus pandemic and the measures taken to safeguard public health. The nature of new trading arrangements between the European Union and the United Kingdom will also provide clarity to the businesses. The responses from the households, financial markets and corporations will collectively play a vital role in the transition phase of recovery.

With so many factors at stake, investors, traders, economists, the World Bank, International Monetary Fund, Bank for International Settlements, European Union and other international think-tanks are keen to see how BoE will implement the new regime and keep the economy afloat.