Tuesday , January 19 2021

Will negative interest rates work in the UK?

The UK is looking for ways to set itself apart from its European neighbours after Brexit. On monetary policy, however, Britain could soon become more European. The Bank of England is studying the possibility of cutting interest rates below zero, as central banks in Denmark, Sweden, Switzerland and the euro zone have all done in the recent past.
Policy makers should embrace the idea with enthusiasm. As Silvana Tenreyro, a member of the bank’s rate-setting Monetary Policy Committee (MPC), said in a speech, the international evidence shows negative rates are a helpful tool to boost growth and lift inflation. The criticism that they cause more harm than good appears vastly overblown.
The Bank of England is undergoing preparatory work to understand whether it would be feasible to cut the bank rate from its current level of 0.1% into negative territory. With the UK economy in a deep recession and inflation well below the bank’s 2% objective, it’s only natural to look for new things to try. But policy makers are divided, with the MPC’s internal members the most resistant to taking this controversial step.
The intellectual battle around negative rates goes as follows. Their supporters believe charging lenders for the money parked with the central bank will prompt them to extend more credit. Negative rates also discourage investors from holding their money in one’s domestic currency, causing it to depreciate, which in turn can boost exports and make imports more expensive.
Finally, if banks pass some of the extra costs on to savers, they will spend or invest more to avoid keeping money on their bank accounts, which in turn will help the recovery.
The critics, including several Wall Street executives, retort that taking rates below zero induces excessive risk-taking by investors who search for yield in ever more exotic realms of the financial sector. As far as the banks themselves, sub-zero rates are seen as too painful for profitability, leading them to cut back on lending to shield margins. Finally, naysayers argue, negative rates can actually push consumers to save more as they fear for the risk of ever higher fees on their deposits, which can become a drag on economic growth.
The Bank of England’s policy-setters have one big advantage as they weigh these opposing arguments: They can benefit from the hindsight of other countries that have already made the leap into negative territory.
The UK has a number of peculiarities to take into account.
—Bloomberg

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