Markets brace for negative interest rates by the end of the year

Markets are now bracing for the Bank to enter the uncharted territory with investors pricing in rates to drop below zero by the end of this year. The Government issued debt with a negative yield for the first time ever on Wednesday amid the speculation. Investors were paying the state for the pleasure of lending it money.

Allan Monks, economist at JP Morgan, says Bailey’s comments “moved the dial” but adds it will take the Bank “a while before it feels comfortable in using the tool”.

He says: “The appeal is likely to rise now that rates have hit zero and the consideration is increasingly born out of necessity.”

Central banks slashed rates close to zero to stimulate lending and growth after the financial crisis. But a more unconventional approach has been taken in the weakest economies when borrowing costs hit the floor.

Under negative rates, depositors pay to keep their money with the bank rather than receive interest. The European Central Bank and Japan have cut their deposit rates into negative territory, meaning banks that park their excess money at the central bank are charged interest for doing so.

The policy aims to simultaneously cut borrowing costs and encourage banks to lend by making it costly to hoard reserves with the central bank.

This reversal of the norms can come at a cost, however. Economists fear the cure of negative rates becomes worse than the disease.

“There are some serious potential negatives in terms of whether you stimulate or hold back credit growth,” explains Ian McCafferty, a former Monetary Policy Committee member at the Bank. “If you go too negative, people prefer to hold cash than put deposits into the banking system and that has negative repercussions.”

McCafferty also highlights the impact on bank profitability. Economists worry that damaging the banking system could make the policy counterproductive for the economy as margins on lending are squeezed. Lenders in the eurozone have complained they have paid €25bn (£22.4bn) for negative rates since they were introduced in 2014, potentially hampering their ability to supply credit.

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