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The Bank of England has stoked expectations of an unprecedented move to negative interest rates as new pandemic restrictions cast a shadow over the recovery.
In a Sunday Telegraph interview, Monetary Policy Committee member Silvana Tenreyro rejected criticisms over the policy, insisting the evidence from other countries was “encouraging” and that banks would cope with further pressure on their finances.
Last week, the Bank launched formal talks with the Prudential Regulation Authority about the operational practicalities of the policy, hitting the pound.
Andrew Bailey, the Bank’s Governor, who has shifted his position on taking rates below zero since March, described other countries’ experiences as a “mixed bag” last week.
However, Ms Tenreyro said: “There has been almost full pass-through of negative rates into lending rates in most countries.”
She added: “Banks adapted well – their profitability increased with negative rates, largely because impairments and loss provisions decreased with the boost to activity and the increase in asset prices.”
Since March, rates have been at 0.1pc, which is considered to be the lowest they can go. The Bank has been using quantitative easing (QE) and forward guidance to boost the economy instead of rate cuts.
Economists have warned that if official negative rates reduce banks’ profitability, banks may respond by lending less or raising lending rates to protect their margins, undermining the policy.
George Buckley, chief UK economist at Nomura, said: “Do you really want to force banks into lowering mortgage rates when they’re doing the right thing by repricing the risk appropriately?”
Ms Tenreyro added that officials still needed to assess the impact of Chancellor Rishi Sunak’s measures announced on Thursday on incomes and demand, but noted that without the furlough scheme, “unemployment would have been much higher and spending lower”.
She predicts the economic recovery will be shaped like an “interrupted, incomplete V”, in contrast with other more upbeat assessments from Andy Haldane, the Bank’s chief economist.
Also uppermost in the Bank of England’s considerations over negative rates is the potential impact of a no-deal transition from European Union trading arrangements on Jan 1, forcing the MPC to pour on more stimulus.
The Bank’s forecasts are currently based on a deal being struck but there remains a gulf between the two sides on topics including state aid and fishing rights.
A new CBI survey has shown more than three -quarters of businesses want a deal to be agreed, with almost half of respondents saying that the impact of dealing with Covid-19 has hindered preparations for Brexit.
Rob Wood, chief UK economist at Bank of America, said: “I expect the Bank of England to cut rates to zero, not negative, because at best negative rates have a marginal stimulus effect but that’s the only ammunition left in the Bank’s cupboard – it’s not that negative rates have become a better policy tool since March.
“The question then is whether the current Covid-19 restrictions are sufficient to slow the spread. This will have an important effect on the outlook for growth and employment.”
Kallum Pickering, senior economist at Berenberg Bank, said: “The obvious risk is if you get a disorderly, hard exit from the single market. That would raise the chance of negative interest rates.”
Instead, Mr Pickering predicted an additional £100bn of QE in November, adding: “There are more merits for yield curve control in the UK than there are for negative interest rates.”
He added that the Chancellor’s announcements would barely cushion the expected autumn jobs crisis.
“At the margin, it might mean unemployment’s a bit lower in the fourth quarter of this year than it would have been otherwise – the spike in November will be a bit lower,” he said.