BOE Steps Up Negative Rates Work as Economic Threats Mount

(Bloomberg) -- The Bank of England gave the clearest signal yet that it may consider cutting interest rates below zero for the first time in its history as the economy faces a surge in coronavirus infections and the risk of a no-deal Brexit. The pound fell.

With multiple threats to the outlook looming, the BOE will begin “structured engagement” with U.K. bank regulators on how it might implement negative rates. Governor Andrew Bailey said last month the policy has become part of the central bank’s toolkit.

The comments in the minutes of Thursday’s policy decision prompted money market traders to bet that the next 10 basis points of easing will come in February, with another cut of the same magnitude to follow after the summer. The pound weakened, and was trading down 0.7% at $1.2876 at 1:36 p.m. in London.

The U.K. is heading into the final few months of the year grappling with a resurgence in virus infections, fresh social restrictions to counter them, and fears that unemployment could spike when government support for wages is withdrawn next month. Adding to the potential for economic turmoil, Prime Minister Boris Johnson’s threats to redraw his Brexit deal with the European Union could scupper any chance of a trade accord before the Dec. 31 deadline.

Before Thursdays’ decision, economists were already forecasting that bond purchases would be expanded by 50 billion pounds ($64.4 billion) in November, and market pricing pointed to rate cuts next year. The BOE kept its benchmark rate at 0.1% for now, and the bond-buying program at 745 billion pounds.

“The bank is leaving all options on the table, due to elevated uncertainty.” said Jeremy Stretch, head of G-10 currency research at Canadian Imperial Bank of Commerce. “We still expect QE to be the first port of call. Expect the bank to keep negative rates as an offset to any no deal Brexit.”

What Bloomberg’s Economists Say...

“The Bank of England kept its policy options open at its September meeting. There was no clear signal that more easing is imminent, but the emphasis on risks in the minutes, particularly in relation to the labor market, left the possibility of more stimulus firmly on the table.”

-- Dan Hanson, senior U.K. economist. Read his REACT.

Just last month, the BOE warned that negative rates could be damaging to the U.K. financial system, which would explain why it wants to figure out a possible route to them with the Prudential Regulation Authority. In its August Monetary Policy Report, it said the impact of the virus on the economy will mean loan losses for banks as unemployment rises and businesses collapse.

“As a result, implementing negative policy rates might be less effective in providing stimulus to the economy at the current juncture than at a time when banks’ balance sheets are improving,” it said then.

Officials said that while recent data has been a little stronger than expected, there is still “a risk of a more persistent period of elevated unemployment” than in previous forecasts. The BOE now expects output to be 7% lower in the third quarter than at the end of 2019. Projections given in August showed an 8.6% decline.

“The Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit,” it said.

Hours before the decision, the Federal Reserve and Bank of Japan both kept rates unchanged, with the Fed signaling U.S. it’ll stay near zero for at least three years. The BOE repeated its pledge not to tighten until U.K. inflation, currently at 0.2%, is sustainably moving toward its 2% target.

A dive into sub-zero rates would put the BOE on a path already taken by some European peers and the BOJ, giving it some clues on how to best structure the policy. The European Central Bank, with a policy rate of minus 0.5%, has offered banks partial exemptions to ease the pain of the policy.

Negative rates work as a charge on the deposits that banks keep at the monetary authority. Exemptions try to counter concerns that lenders, unable easily to pass that cost onto savers, will pull back on credit to the real economy. The ECB also offers long-term funding to banks at an ultra-low interest rate if they use that cash for loans.

©2020 Bloomberg L.P.