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  • Ivy Washington posted in the group Business

    1 week, 2 days ago
    The Bank of England governor, Andrew Bailey, has paved the way for negative interest rates in a dramatic move that illustrates concerns inside the central bank that the impact of the coronavirus lockdown will be longer and deeper than expected.

    Bailey said central bank officials were actively considering all options to help see the economy through a deep recession and told MPs that it would be “foolish” to rule out cutting the cost of borrowing to below zero.

    The move came after Britain sold a government bond with a negative yield for the first time.

    A negative yield effectively means investors have to pay to lend money to fund the government’s response to the Covid-19 pandemic. In searching for a safe haven for their money they bought gilts knowing they would get back less than they paid for them when the bonds mature in three years’ time.

    The £3.8bn gilt auction by the debt management office (DMO) sold three-year government bonds with a yield, which indicates the interest paid, of -0.003%.

    Only last month Bailey in effect ruled out cutting the Bank’s own lending rate from 0.1% to below zero. However, the deepening crisis has persuaded the Bank that it needs to consider all tools available to make credit cheaper for embattled businesses and households.

    The move would be unprecedented in the Bank’s 325-year history and would leave only the US Federal Reserve among major central banks to rule out negative rates.

    Japan’s central bank and the European Central Bank, which sets interest rates for the 19-member eurozone, have already adopted negative interest rates to stimulate borrowing and discourage saving.

    Donald Trump has implored the US central bank in a series of tweets to cut rates to below zero as a way to boost the ailing US economy. More than 20 million people in the US lost their jobs in April to take the unemployment rate above 14%.

    Bailey, who took over from Mark Carney in March, said the Bank was keeping the outlook for how low UK rates could go – and other monetary policy tools available – under “active review”.

    “We do not rule things out as a matter of principle. That would be a foolish thing to do. But that doesn’t mean we rule things in either.”

    He said the Bank believed the benefits weaken as rates approach zero and could even be “counterproductive” when negative.

    Policymakers are “looking carefully” at the experience of other central banks that have cut rates into negative territory, he said, adding that the reviews were “mixed”.

    His comments come as official figures showed inflation plunging to a near-four-year low of 0.8% in April. Bailey is under pressure to use all the Bank’s tools to stimulate the economy and bring inflation back to an annual target of 2%.

    After the 2008 banking crash, the Bank refused to adopt negative rates, arguing that building societies and other financial institutions would become unprofitable and could go bust if they were forced to pay to keep funds with the central bank.

    It is understood that officials remain concerned that negative rates would undermine the profitability of the banking and building society sector, though substantial increases in reserves of the last 10 years would provide a cushion, at least in the short term.

    The DMO is holding frequent gilt auctions to pay for the extra government borrowing resulting from the effective shutdown of the economy.

    Yields on gilts with a short maturity date are sensitive to City expectations about the future path of interest rates, and the drop in the annual inflation rate from 1.5% to 0.8% fuelled speculation that the Bank would act soon to cut rates.

    Despite concerns that the government would have to offer higher yields to investors to persuade them to finance the highest borrowing in peacetime, demand for gilts has been strong. According to the DMO, bids for the July 2023 gilt were worth £8.1bn – more than double the £3.75bn on offer.

    Kit Juckes, a macro strategist at Société Général, said it would be a bad idea for the Bank to lower rates below zero.

    “The chancellor has dramatically increased government borrowing and the Bank of England is buying the economy time by mopping most of it up,” he said. “How on earth does it make sense to even consider adding negative rates to the mix?”

    The Guardian

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