Bank may not be able to use negative rates until H2 2021 - Capital Economics
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Bank may not be able to use negative rates until H2 2021

UK Economics Update
Written by Thomas Pugh
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  • The Bank of England may not be ready to use negative interest rates until H2 2021. And by then, COVID-19 restrictions might be easing and the economy could be growing rapidly. In any case, if the Bank does loosen policy further, we suspect it will use more Quantitative Easing rather than negative interest rates.
  • The third COVID-19 lockdown in England, scheduled to run from 5th January until at least 15th February, has made markets even more convinced that the Bank of England will turn to negative interest rates over the next two years and perhaps even within the next six months. (See Chart 1.) However, there are two things holding the Bank back from being able to do negative interest rates now, even if it wanted to.
  • First, there is an operational issue of whether financial institutions can actually deal with zero or negative interest rates. Many of their computer systems were not designed to handle zero or negative interest rates, so bankers can’t even type in -0.1%. On 12th October, the Bank launched a consultation asking what financial firms would need to do to prepare for zero or negative rates, including asking whether they could implement short-term workarounds until they had permanently fixed their systems.
  • The Bank is due to report on its findings from this consultation at the next Monetary Policy Committee (MPC) meeting on 4th February. It would then presumably have to tell financial firms to prepare their systems and give them time to implement any changes. It’s anyone’s guess how long firms might need, but we suspect the Bank would probably give them at least 3-6 months. That means it could be the second half of 2021 before the Bank feels it is operationally ready to implement negative interest rates. (See Table 1.)
  • Second, the Bank wants to put in place systems to minimise the costs of negative interest rates to commercial banks. One big issue is that while banks are charged to hold money at the central bank, they may be reluctant to pass this cost on to customers in the form of negative deposit rates. This weighs on banks’ profits and their willingness to lend. Mitigating this would probably mean shifting to some sort of excess reserves system where the Bank of England only charges negative interest rates on a portion of the reserves that commercial banks hold with it. (See here.) We don’t know how far along this path the Bank has already gone. It may already be prepared to do it or it may need more time. But we suspect that it is the operational issues that are the most important in determining when it is ready to use negative rates.
  • Of course, even once it is operationally ready to implement negative rates, there is no guarantee that it would want to do so. The MPC has previously said that negative rates work best in an economic upswing when banks are less concerned about loan losses. And if COVID-19 restrictions start to be eased from May, as we expect, then by the time the Bank is ready to use negative rates, GDP growth may already be accelerating, reducing the need for further support.
  • Admittedly, the third lockdown increases the chances that the Bank will want to do something to support the economy. But we wouldn’t be surprised if it increased the pace of the QE already announced or tweaked the terms of the TFSME. But we aren’t expecting any new policy announcements. And even if there is further policy loosening, we think it will be in the form of additional QE, rather than negative interest rates. As such, we think there is some scope for market interest rate expectations and gilt yields to rise.

Chart 1: Bank Rate Expectations (%)

Table 1: Timeline of Negative Interest Rate

Sources: Refinitiv, Capital Economics

Sources: Bank of England, capital Economics

Thomas Pugh, UK Economist, +44 (0)7568 378 042,