Traders Bet U.K. Will Have Negative Interest Rates by Year End

(Bloomberg) --

Investors are now betting the U.K. will join the negative-rates club by the end of December.

Spurred by Bank of England Chief Economist Andy Haldane’s comments that the institution is looking at unconventional monetary policies -- including negative rates -- more urgently, overnight interest-rate swaps for December’s meeting dropped below 0% for the first time. Money markets last week had seen the move in a year’s time.

Silvana Tenreyro, another policy maker, went one step further late on Monday, adding that sub-zero rates have had a positive effect in Europe.

“With inflation below target, the recovery incomplete and tighter fiscal policy in future years we expect the BOE to implement further stimulus,” wrote Robert Wood, chief U.K. economist at Bank of America Merrill Lynch, in a note to clients. “It seems increasingly hard to us to rule out a cut to zero.”

Bank of America also expects the BOE to boost its quantitative-easing program by at least 200 billion pounds ($242 billion) and to lower rates to 0% in August, on top of up to 75 billion pounds of extra buying in June.

Market pressure on the U.S. and the U.K. to cut rates below zero is growing with the coronavirus continuing to weigh on economic output. Still, officials are reluctant to make the move, citing risks that a negative interest-rate policy stifles bank profitability, and harms the economy more than it helps.

Morgan Stanley has also expressed such concerns, arguing in an emailed note that both Japan and the euro area -- which have rates in negative territory -- have seen greater underperformance of stocks, economic growth, loan growth and bank valuations than the U.S.

“We think that the Federal Reserve’s long-standing reluctance to take rates negative is well founded, and our economists and interest-rate strategists expect it to hold this line,” wrote Andrew Sheets, chief cross asset strategist at the U.S. bank.

Sub-Zero

The cost of lending between banks has also been caught up in the debate over subzero rates, falling to within a basis point of an all-time low.

Three-month sterling libor had already been on track to reach an all-time low before traders ramped up pressure on central banks to consider rates below zero. The drop on Monday extended its decline to a 14th day and took it to 0.27700%, spurred by a decline in U.S. funding costs and efforts by the BOE to ease liquidity strains. The move lower leaves the benchmark within one basis point of a record.

Meanwhile, the pound has borne the brunt of rate-cut expectations -- as well as renewed fears over a Brexit cliff-edge at the end of this year -- sliding around 1.9% this quarter, more than any other Group-of-10 currency, to $1.2181.

For HSBC Holdings Plc, the BOE may be forced into cutting interest rates below 0% by difficulties in enlarging its other main crisis-fighting tool: quantitative easing.

While still some way off its purchase limit of 70% of a single bond, a level of 50% has been found to be the level at which purchase become more challenging in Japan, it said. It’s there on some shorter-dated bonds already, the bank estimates.

“The Bank of England is burning through its asset purchases at a fast pace but this may not be sustainable over a prolonged period,” wrote Daniela Russell, head of U.K. rates strategy at HSBC. “With more stimulus needed, this could mean a change to how QE is implemented and it may also strengthen the case for negative rates.”

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