How low can the Bank of England go? Six considerations for negative interest rates
Go alone for follow the crowd?
For three centuries, the Bank of England had never set its base rate below 2%.
But the economic convulsions of the past decade have driven the base rate to just above zero, and now the Bank is debating whether to follow the example of the eurozone, Japan and several other countries in setting a negative interest rate.
What can we learn from the experience of these countries?
Negative can mean pretty negative
The European Central Bank (ECB) is the most obvious comparator for the Bank of England. It moved gingerly in setting negative interest rates and suggested several times that it would go no further.
But over six years, it has brought its policy rate bit by bit to -0.5%. There is no clear reason why the Bank of England could not do the same.
Retail deposit rates will not go negative
On the whole, negative policy rates have been passed through reasonably efficiently to bond yields, bank lending rates and interest rates for large deposits, especially from companies.
But no bank has sought to impose negative rates on regular retail deposits, for the simple reason that retail depositors would not accept it.
Negative interest rate debate becomes 'very real' as UK inflation plunges to 0.8%
Tailoring negative rate policy to each country's financial sector
Because negative interest rates reduce the interest rate on banks' assets, but not on their retail deposit liabilities, the policy will tend to compress banks' margins.
In principle, that could make banks more wary of extending credit and perversely lead to a tightening of financial conditions.
In practice, itis not so clear cut, because easy monetary policy will also help banks in other ways, such as by reducing their credit losses. In the UK, these concerns apply in particular to the deposit-funded building society sector.
A few examples can illustrate the importance of financial sector considerations. Japan adopted slightly negative interest rates in 2016, but the immediate sharp fall in Japanese bank equity prices called into question how much further the Bank of Japan could extend the policy, and indeed it has not reduced rates further since then.
In the US, the Federal Reserve has so far been adamantly against negative rates, partly on concerns that it would undermine the $4trn US money fund sector.
As the ECB has pushed further into negative rate territory, it has coupled the shift with measures to soften the blow for banks, including allowing them to borrow at interest rates as low as -1%.
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