Tuesday, 13 October, 2020
Tuesday October 13 2020
Unique insight into the world’s biggest economic issues from Ambrose Evans-Pritchard and Jeremy Warner, two of the most influential commentators in the UK.
Wrong, wrong, wrong. Why both in principle and practice the Bank of England should not be imposing a negative interest rate
By Jeremy Warner,
The spectre of negative interest rates, which had previously been dismissed by Bank of England Governor Andrew Bailey, is now firmly on the agenda
Can we please stop talking about a negative Bank Rate; even another dollop of quantitative easing would be preferable to that.
The Bank of England, of course, denies that its letter to banks this week, asking whether they were ready for such a policy move, indicates that it is about to impose one. Definitely not, the Bank insists; it isn’t even asking banks to ensure they are adequately prepared for one. The only intention is to ask about their state of preparedness.
Believe it if you will. The Bank of England does not send out a letter like that without full knowledge of the signal it sends to markets. And this one was loud and clear. With the economy again stalling, all options are back on the table, including taking the Bank Rate negative. A policy which up until now had been pretty much ruled out by Andrew Bailey, Governor of the Bank of England, is now firmly on the agenda.
Before taking the plunge, the Bank needs to ask itself the following questions – will it make any difference, what is the evidence for thinking it would have a positive impact, and might not the negative effects outweigh any positives. If the answer to these questions is no, debatable and very possibly, it shouldn’t be doing it.
This is what the Bank of England had to say about negative interest rates as recently as its August Monetary Policy Report: “Risks to banks’ balance sheets are likely to be rising at the moment. The impact of Covid-19 on the economy will result in losses for lenders, as some businesses fail and some households lose their jobs. 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.”
The purpose of any cut in official interest rates, whether into negative territory or simply a normal, common all-garden cut, is both to reduce the attractions of holding cash, driving savings into riskier assets, and to cut the cost of credit in a way that encourages banks to lend more to the economy.
Theoretically, there is no reason why the effects shouldn’t be just as potent when cutting into negative territory than with any normal interest rate cut when the rate is positive. Theoretically, both achieve the same outcome. Yet when the cause of the downturn is not the business cycle, but an enforced closure of large parts of the economy so as to ensure social distancing commensurate with a pandemic, you have to question whether it would have the normally expected effect.
Cheaper borrowing costs are unlikely to persuade firms to borrow more to stay afloat when their chief concern is not about the costs of the extra borrowing but how they are ever going to repay the money when there is no end in sight to the measures deemed necessary to contain the pandemic. Banks should not be forcing companies and households to borrow what can never be repaid.
The European Central Bank has been operating a negative discount rate since 2014
The chief problem with cutting below the so-called “lower bound” is its effect on the profitability of banks. Broadly, banks make their money on the margin between deposit and lending rates. But in practice, it is difficult-to-impossible to charge retail depositors on their cash balances (wholesale money may be another matter), particularly in the UK, which largely operates on a “free” banking model, where the cost of administering accounts is paid for by the spread between lending and deposit rates.
With a negative rate of interest, you potentially have a situation where the debtor is paid to borrow while the creditor is charged to deposit. That’s a topsy turvy world, and if it badly impacts profitability, then perversely banks may end up lending less to the economy, not more.
The European Central Bank, which has been operating a negative discount rate since 2014, claims to have got around the problem by adopting a two-tier system through which a significant portion of excess reserves are exempt from negative rates. The ECB also provides a facility that allows banks to borrow from the central bank at highly favourable rates, provided they extend sufficient credit to the real economy.
But has any of this really helped? Naturally, the ECB claims it has; it has encouraged banks to provide more credit to the economy while through its mitigation strategies protecting the profitability of the banks.
Maybe, maybe not, but the eurozone economy has hardly been a rip-roaring success over the past six years. I’ve not seen any evidence to suggest the effect is anything other than marginal at best. Is it really worth entirely exploding the notion that debt carries a cost, and deposits some form of return, for such a questionable benefit?
With negative rates, you have the feeling that like governments, central banks are flailing around in their pandemic response. Just being seen to do something, even when ineffective, is the name of the game.
This is not a normal, cyclical demand-side recession, but a self-inflicted supply-side shock. The answer lies in getting to a position where the restrictions can be removed, not forcing depositors to pay for the “privilege” of lending their money. There is frankly not a lot more the Bank of England can do to help matters, other than keep on financing the deficit.
City Intelligence |
Get a daily view on the City’s movers from our columnist Ben Marlow, his stock of the week, and his favourite long read delivered to your inbox from 12pm.
Negative rates have failed everywhere and are the path to Soviet banking
By Ambrose Evans-Pritchard,
International Business Editor
Five years into the global experiment with negative interest rates, we know enough to conclude that it has destructive anthropological effects and does more economic harm than good.
Negative rates do not stimulate lending for useful economic activity. They damage “good” banks by eviscerating their bread and butter business model, but help “bad” banks play the casino.
They can increase precautionary savings by households and therefore drain money out of the real economy. They stretch public tolerance of overmighty central banks to near breaking point.
The Swedish Riksbank abandoned its foray earlier this year. It gamely claimed that negative rates had helped to stave off deflation but global recovery did that for everybody, until Covid hit. In reality the negligible gains were overwhelmed by a catalogue of side-effects, not least the slow destruction of price-signalling and the ecosystem of market capitalism.
The Bank for International Settlements says negative rates – or NIRP – are chiefly intended to drive down the exchange rate. The central banks of Switzerland, Denmark, and Japan openly admitted as much.
The trouble with debasement in a world of near deflation and deficient demand is that everybody wants more stimulus from a cheaper currency. To embrace NIRP takes on the character of 1930s beggar-thy-neighbour devaluation. The US Treasury warned the Bank of Japan (BoJ) that further cuts into negative territory would be deemed currency manipulation, a message heeded in Tokyo.
When the BoJ suddenly went negative in 2016 – after insisting that it was a bad idea, much like the Bank of England until a few weeks ago – the move failed to stimulate lending to small business or for corporate investment. Credit went into a property boomlet instead.
Through the looking glass: negative rates can set off a scramble for cash and safe deposit boxes
Former BoJ board member Sayuri Shirai said it cut across QE by creating a shortage of bonds on the market. It eroded the net interest margin for lenders. “There was a direct adverse impact on commercial banks’ profitability. Financial conditions deteriorated for institutional investors. Bond market liquidity deteriorated. Money market funds shrank quite substantially,” she told a post-mortem on the NIRP misadventure.
Furthermore, she said it had a corrosive psychological effect – known as the Alice in Wonderland syndrome, when you walk through the mirror into a world that has become unhinged. It sets off a scramble for cash and safe deposit boxes. It leads to higher inert savings. In other words, it can be contractionary.
One reason the US Federal Reserve shuns NIRP is because it threatens to destabilize the $2 trillion money market industry, but it is not the only reason.
A paper last month for the San Francisco Fed issued a withering verdict on Europe’s experiment. “Both bank profitability and bank lending activity erode more the longer such negative policy rates continue,” it said.
Its review of 5,300 banks found that there may be an initial bounce but then “lending declines over the next two years, more than reversing any initial gains. As negative rates persist, they drag on bank profitability even more,” it said.
It is Europe that has drunk deepest from the intoxicating waters of the Pierian Spring, going all the way to minus 0.5pc in a belated attempt to fight deflation, a pathology caused by its own policy errors years ago.
It has done this even though the European Central Bank itself published a paper in 2018 concluding that NIRP tightens economic conditions, is a “negative shock to the net worth of banks”, and “could pose a risk to financial stability”.
It found that banks dared not pass on negative rates to their savers from fear of deposit withdrawals. Those lenders that depend heavily on stable savings deposits – as opposed to more fickle capital markets – tried to compensate for the hit to profit margins by doing two things: they cut lending; and they dabbled in gambling on high-risk markets. In short, they made the whole system more dangerous and dysfunctional.
Professor Richard Werner, a bank expert at Oxford University, said the outcome is progressively ruinous for Germany’s 1,250 savings banks and cooperative lenders, which rely on deposits from savers and have intricate ties with local business.
These banks account for 90pc of lending to small firms (SMEs). They provide credit for much of the Mittelstand engineering and machine tool family firms. Prof Werner said they are the lifeblood of the Wirtschaftswunder, arguably the reason why Germany has had such a successful industrial economy for over 200 years.
“What do negative rates do? They kill the banks. Smaller firms are being gradually frozen out of the lending markets,” he said.
“When you get into the nitty gritty, the policy is just a tax on lenders. The ECB has introduced ‘tiering’ to reduce the blow but that does not change the logic at all.”
The NIRP structure favours mega-banks with no local or intimate ties to the productive economy, and which have a strong incentive to pump up the parasitic property market and to make their living from speculative capitalism.
“What’s more, central banks have a conflict of interest since they want to step into the arena themselves as a player by offering current accounts, which they call a ‘digital currency’ to confuse everybody. This is how we end up with centrally-planned credit and the Sovietisation of banking,” he said.
Has the ECB been at all chastened as NIRP hits the “reversal rate”, the point where it demonstrably does more harm than good? Apparently not. Christine Lagarde wants to go even further. She has floated the prospect of minus 2pc. But to do that you have to start taking coercive measures to ban cash and outlaw safe-deposit boxes.
There are good arguments for or against quantitative easing. But steeply negative rates are something quite different. They are a cancerous tumour on the free enterprise system.
Thank you for being a Telegraph subscriber.
Your support makes newsletters like Economic Intelligence possible, and we want to ensure that you’re making the most of your subscription.
Join the panel | As a valued newsletter reader, we would like to invite you to join our Newsletter Panel. It’s a chance to have your say on what you think of our newsletters, and to be entered into a monthly prize draw when you participate in discussions and polls. Find out more here.
The best of Ambrose and Jeremy last week
Boris Johnson wants to build a New Jerusalem, but first he has to get through this winter, says Ambrose Evans-Pritchard
Ambrose Evans-Pritchard: Boris Johnson will never build his New Jerusalem unless he listens to the IMF right now
Neither writer can guarantee that they will be able to reply to all those who email, but they do appreciate your feedback.
If you have any issues, please visit our help page. If you have questions about your Telegraph subscription, including delivery issues or technical ones, please visit this page and contact us that way.
We have sent you this email because you have either asked us to or because we think it will interest you.
For any other questions, please visit our help page here.
Any offers included in this email come with their own Terms and Conditions, which you can see by clicking on the offer link. We may withdraw offers without notice.
Telegraph Media Group Limited or its group companies – 111 Buckingham Palace Road, London SW1W 0DT. Registered in England under No 451593.
Archr LLP is Authorised and regulated by the Financial Conduct Authority (FCA reference 617163).
Archr LLP is not covered by the Financial Services Compensation Scheme (FSCS).
Archr is registered in England and Wales No. OC371018. Registered office 115B Drysdale Street, Hoxton, London, United Kingdom, N1 6ND
This message may contain confidential or privileged information. If you are not the intended recipient, please advise us immediately and delete this message. The unauthorised use, disclosure, distribution and/or copying of this email or any information it contains is prohibited.
This information is not, and should not be construed as, a recommendation, solicitation or offer to buy and sell any securities or related financial products. This information does not constitute investment advice, does not constitute a personal recommendation and has been prepared without regard to the individual financial circumstances, needs or objectives of persons who receive it.
You are receiving this email because you are a valued client of Archr.
This message may contain confidential or privileged information. If you are not
the intended recipient, please advise us immediately and delete this message.
The unauthorised use, disclosure, distribution and/or copying of this e-mail or
any information it contains is prohibited.
This information is not, and should not be construed as, a recommendation,
solicitation or offer to buy or sell any securities or related financial
products. This information does not constitute investment advice, does not
constitute a personal recommendation and has been prepared without regard to
the individual financial circumstances, needs or objectives of persons who