Negative Expectations Nick Keeling

Expectations for negative rates, apparently kicked into the long grass by the Bank of England as recently as the August Monetary Policy Report, have received a boost following the publication of the minutes of the September MPC meeting.

Like a surprise ending to a film, the penultimate paragraph prompted a shock response; gilt yields dropped relatively sharply, with the 10-year gilt yield dipping below 0.16% on Thursday afternoon, from a pre-meeting 0.23% level. It subsequently rose back to close at 0.19%.

Interestingly, the actual wording (below, italics added by the author) was fairly dry, but the insinuation is that monetary policy makers are edging towards negative rates being included as a fully-fledged option in the policy toolkit. And those options are there to be used…

“The Committee had discussed its policy toolkit, and the effectiveness of negative policy rates in particular, in the August Monetary Policy Report, in light of the decline in global equilibrium interest rates over a number of years. Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative Bank Rate could be implemented effectively, should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates. The Bank of England and the Prudential Regulation Authority will begin structured engagement on the operational considerations in 2020 Q4.”

Should this be seen as another step in the Bank’s communication strategy, either with the goal of easing in negative policy rates or talking down levels without taking overt action? Or is this simply an indication that work in this area is taking place, which is nothing new? Andrew Bailey has already noted that the Bank is carrying out a review of its policy tools, including negative rates, and it makes sense that the MPC will need to be aware of this process, the likelihood of its availability as a policy tool and the repercussions of its use.

Whichever way you see it, this step may not have been necessary without the spectre of a no-deal Brexit once more rearing its ugly head. While the Bank’s reticence on negative rates in the August Report dampened expectations, both the seeming lack of process in Brexit negotiations and the government’s rather questionable response to this situation have pushed the issue once again to the fore. Add in the already expected slowdown in the economic recovery in Q4 and you have fertile ground for negative expectations to grow.

The most interesting development, perhaps, relates to the suggestion in the August Report that negative rates are only effective when bank balance sheets are in a healthy position. With the expectation that rising unemployment in the coming months will prompt an increase in bank loan defaults, how will the Bank implement a policy that will put further pressure on commercial banks’ financial positions? The inclusion of the Prudential Regulation Authority (PRA) therefore makes sense – the potential for a policy tool to damage the financial health of the sector requires the regulatory knowledge of its impact and, perhaps, solutions to ameliorate this impact. If Bank Rate does become negative, it could be part of a package of tools designed to both ensure transmission into the real economy and assist the banking sector to absorb the financial impact. After all, policymakers will be more likely to use this tool if assured of its effectiveness and reduction in negative effects.

What does it mean for our clients? Whether you see this as the Bank simply being transparent on an issue of interest or a ploy to embed expectations, the market response brings a negative rate world closer for investors, whether or not Bank Rate is cut from current levels. The outlook for borrowers, however, certainly looks easier.