Negative Interest Rates in the UK: Implications for Banks
On 4 February 2020, the Prudential Regulation Authority (PRA), the United Kingdom’s financial services regulatory body, published a Dear CEO letter highlighting that it would take about six months for banks to be operationally ready to implement zero or negative interest rates. This sparked some questions regarding the Bank of England’s monetary policy stance and the potential impact that the negative rates could have on banks and asset owners of banking stocks.
The PRA asks banks to assess their preparation for negative interest rates
The MPC report points to uncertain macro outlook
A number of advance economies already operate with negative interest rates
Divergent views exist on the impact on banks’ profitability, but depressed valuations observed
Why is the BoE Contemplating Negative Rates?
Since the publication of the Bank of England’s (BoE) monetary policy report on 5 November 2020, the COVID-19 crisis has seen not only positive developments through the approval of a number of vaccines but also negative effects of stricter lockdown measures due to the emergence of new variants. Consequently, the economic outlook for the United Kingdom (UK) remains highly uncertain and the pandemic’s effects should weigh on the country’s activity over 2021 as a whole by somewhat more than in the November projections.
The UK has also moved to a new trade agreement with the European Union (EU) starting 1 January 2021. In its February report, the BoE’s Monetary Policy Committee (MPC) laid out its assumption that the UK’s trade is expected to be around 10.5% lower in the long run under the new agreement with the EU. Taken together, the MPC expects the UK’s GDP to rise by 5% in 2021 versus 7.25% projected in the November report. The last BoE meeting on 4 February pointed to a more pessimistic stance toward growth and assumed a more dovish stance than what the market expected, which led to a sell-off in UK government bond yields.
The BoE clearly wants to have its tool kit ready if the economic data were to point toward the need for additional policy support. There are divergent views on whether negative interest rates boost economic growth or not. A speech given by an external MPC member, Silvana Tenreyro, set out a view that this has worked effectively in other countries through standard cost of capital and exchange rate mechanisms, which have led to higher consumption and investments.