HomeBank of England Talks About Negative Rates

Bank of England Talks About Negative Rates

7 August 2020 By Mircea Vasiu

Yesterday’s Bank of England’s (BOE) decision came and went unnoticed. But it left some traces worth mentioning for the ones interested in the future path for the United Kingdom’s monetary policy.

The BOE finds itself at a crossroads at this point in time. On the one hand, it must handle the devastating impact of the coronavirus crisis. The Brexit December deadline puts even more pressure on the country’s finances and future monetary policy.

Negative Rates Possible, But Not So Soon

The most expected thing out of the BOE’s decision yesterday related to clues about the possibility of implementing negative rates in the United Kingdom. The BOE did not disappoint, in the sense that it covered the subject extensively.

While not apparent in the official statement, the negative interest rates environment was intensely discussed by BOE’s Governor Bailey. He mentioned clearly that the negative rates are in the toolbox, albeit he downplayed the idea of implementing them soon.

However, investors tend to have a different perception towards statements like the one BOE delivered yesterday. All traders know that central bankers use forward guidance and all possible tools to make their intentions public.

At first, they will just introduce them as alternative solutions to the current economic situation. Unconventional measures like negative rates are always presented as just-in-case solutions.

Why? The aim is to contain the impact on financial markets when they are introduced. It does not mean that they will, indeed, be used, but if they do, it should not come as a surprise.

Therefore, yesterday’s discussion was interesting. Governor Bailey even stressed that the effectiveness of negative rates depends on where the economy is, from a business-cycle point of view.

Two points are worth mentioning here. First, he mentioned “effectiveness”, meaning the BOE believes negative rates do work to some extent to stimulate economic activity. Second, by introducing the business cycle, maybe as a threshold for applying negative rates, it referred to specific phases of the business cycle.

If the European Central Bank (ECB) stands as a benchmark, the negative interest rates work during economic expansion. During contraction, we do not know, as there is not enough data to draw proper conclusions.

But even so, the BOE’s situation differs from the ECB’s one. For example, the ECB sets three interest rates, and only one is beyond zero (i.e., the deposit facility rate).

One thing is clear – the GBP volatility is poised to rise as we come closer to December’s Brexit transition period deadline. Those that better understand the BOE’s message will have a competitive advantage trading GBP assets.