Calling for near zero positive interest rates has become a hawkish position in the UK. In the Bank of England, debates over the use of negative interest rates are gaining traction. For now, most households and companies are risk-averse. Later, negative rates could play a useful role as a stimulus to investment once a post-pandemic recovery has begun.
Sterling rallied on Monday when Dave Ramsden, the deputy governor for markets and banking, said that the central bank was not about to use negative rates. That does not mean the BoE has rejected the policy outright. Using negative rates remained very much in the bank’s “toolbox” for the future, he said. His boss Andrew Bailey said something similar on Tuesday last week. Two-year gilt yields, whose spread with German Bunds have closed dramatically this year, could slip below zero in the year ahead.
Bank shareholders, already battered by years of declining rates, will not applaud the idea. After all, Euroland bank stocks have slid against the broader market indices following the continent’s downtrend in bond yields. The proportion of bonds with negative yields has grown from hardly anything five years ago to a quarter of the market. Yes, borrowers including governments benefit from declining interest payments. But ever-lower yields are bad news for pensioners relying on income from reasonably safe investments.
Shareholders and chief executives of European banks want rates to stay well above zero to improve loan pricing. They do not want to impose a negative interest rate on customers’ deposits.
Yet even with rates negative, lending margins can hold up, even rise. This year, the European Central Bank pushed its policy interest rate deeper into negative territory. In Germany and Spain, corporate lending rates have still risen by roughly 20 to 30 basis points since the end of 2019. Lending volumes have improved, according to economists at Jefferies. It is still early, but the reaction suggests negative rates are not causing damage.
The potential benefits of negative rates should not be dismissed. But timing matters; the risk appetite of borrowers must return first. Pushing rates below zero will have the greatest impact once pandemic-related uncertainty lessens and economic recovery has begun.