By Andy Bruce, David Milliken and William James
LONDON (Reuters) - The Bank of England said it was looking more closely at how it might cut interest rates below zero as Britain's economy faces a triple whammy of rising COVID-19 cases, higher unemployment and a possible new Brexit shock.
The BoE's monetary policymakers said the world's sixth-biggest economy was recovering faster than they had thought as recently as last month, and they voted unanimously to keep their main stimulus programmes on hold for now.
But the BoE said its Monetary Policy Committee had been briefed on 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".
Governor Andrew Bailey and some of his colleagues have previously said that they were looking at the pros and cons of following the lead of other central banks, including those in the euro zone and Japan, and taking rates negative.
The BoE said on Thursday that it would "begin structured engagement on the operational considerations in 2020 Q4", a sign that it would look at how to take rates below zero without hurting banks' ability to lend and damaging the recovery.
Sterling fell sharply after the announcement, weakening by around 0.6% on the day against the U.S. dollar <GBP=> to below $1.29.
Britain suffered the biggest economic contraction among Group of Seven nations between April and June, slumping by 20%, and like other central banks around the world, it is studying how best to use its limited room for manoeuvre.
On Wednesday, the U.S. Federal Reserve promised to keep rates near zero percent until inflation is on track to "moderately exceed" its 2% inflation target "for some time".
Economists at Morgan Stanley said they still expected the BoE's next move to be an increase in the size of its bond-buying programme - which already stands at nearly $1 trillion - in November.
Negative rates were likely if Britain fails to get a trade deal with the European Union, they said.
The British central bank is gearing up for what looks like a tense seven weeks before its next policy meeting in November with coronavirus restrictions already tightening in many parts of the country and London and Brussels at loggerheads over a post-Brexit trade deal from Jan. 1.
On top of that, finance minister Rishi Sunak has ruled out extending his huge coronavirus job retention scheme which is due to expire on Oct. 31, although he has promised to be "creative" to keep people in work.
"Storm clouds are gathering with new social restrictions in place, the furlough scheme unwinding and Brexit rearing its head again," said Jon Hudson, UK equities investment manager at Premier Miton. "With inflation well below target, it's therefore unsurprising to see the MPC hinting at further stimulus in the coming months."
As expected, the BoE kept its benchmark interest rate at 0.1% and left unchanged the size of its bond-buying programme at 745 billion pounds ($966 billion).
Economists polled by Reuters had expected the BoE to hold steady at its September policy meeting.
The Monetary Policy Committee said the economy was likely to continue its recovery and be 7% below its end-2019 size in the third quarter. In August the BoE had said the economy would be 9% below its end-2019 level in Q3.
"Recent domestic economic data have been a little stronger than the Committee expected at the time of the August Report, although, given the risks, it is unclear how informative they are about how the economy will perform further out," it said.
(Writing by William Schomberg; Editing by Catherine Evans)