Quantitative Easing (QE, the buying of government debt) was introduced in 2009 as conventional monetary policy was no longer up to the task. From nothing pre-crisis, the Bank of England (BoE) now holds a quarter of UK sovereign debt. As QE’s power has waned, so new tools are being considered, which is why the BoE wrote a letter to UK bank CEOs in October asking if they were operationally ready for negative interest rates. This was not a statement of intent; however, it has once again brought negative rates to the fore.
They have been used in Japan, the Eurozone, Denmark, Sweden, and Switzerland in recent years, and are not deemed a great success in any of these areas. Under such a policy, retail and commercial banks are required to pay interest to keep any excess reserves with the central bank. The theory is that this encourages banks to put their money to more productive use elsewhere, spurring economic growth.
However, this is another step on the journey of providing a backstop for markets, and therefore further risks eroding the incentives for the private sector to maintain adequate buffers against financial stress. To be clear these negative rates will likely never be charged to retail customers because banks would immediately see a drain of their deposit base. As a result, banks are forced to absorb the losses, and as they grease the wheels of the economy, anything that undermines their ability to operate, undermines the whole economy.
Falling mortgage costs are great for property markets, but what about savers? If you are an institutional saver, paying to keep your cash on deposit means that the asset is made into a sort of liability. If you are saving a pension, then negative rates mean that buying bonds maturing when you retire would guarantee you a loss. And if you are a charity, then it becomes almost impossible to get a reasonable yield on your portfolio without taking on significant risk.
Negative rates feel unnatural. The key here is investor psychology and the behaviour it engenders. They knock public confidence, and as in the folktale of the emperor’s new clothes, maintaining confidence is central to the whole affair. The BoE realises this, but its existing arsenal is failing. We do not think they will take this step, however if conditions deteriorate, they might.
Edward Donati is an investment manager at Ruffer
Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.