Advertisement

Negative rates may be needed to boost recovery, says Bank official

Vlieghe
Vlieghe

Negative interest rates could soon be needed to boost the economy as the second Covid wave hits the recovery, a top Bank of England policymaker has indicated.

Gertjan Vlieghe, a member of the Bank's Monetary Policy Committee, said growth was flagging and thus more stimulus could be on the way.

In countries where negative rates have been tried, “the effect has generally been positive”, he said.

It would reduce costs for borrowers, but savers would suffer and the unprecedented policy could have serious repercussions for banks' profits and building societies' operations. Bosses have warned it could potentially even threaten the "free banking" model under which customers who are in credit pay no fees for current accounts.

The Bank has taken interest rates to a record low of 0.1pc and used quantitative easing (QE) to inject more money into the system and lower rates in financial markets.

However, Mr Vlieghe said that “QE is probably less potent now than in March”, which meant the Bank needed to consider other options including taking rates below zero.

He fears that without more help, the economic recovery would struggle.

“There is a tremendous challenge ahead. Given that virus prevalence has been increasing again recently, it is likely to weigh more heavily on economic activity. Indeed, it appears that the downside risks to the economic outlook are starting to materialise," Mr Vlieghe said in a speech broadcast online.

"In my view, the outlook for monetary policy is skewed towards adding further stimulus. My own view is that the risk that negative rates end up being counterproductive to the aims of monetary policy is low.”

The Bank does not appear ready to take the plunge sub-zero yet, but has been working on the idea for months and could be making final preparations for the move.

“A move to negative rates, if it happens, would require three conditions to be met: it must be feasible, effective and appropriate,” Mr Vlieghe said.

This means the financial system would need to be able to handle the rates operationally. Last week officials discussed the idea with banks to ensure their computer systems could cope with negative numbers.

It also means policymakers would need to be confident the benefits would outweigh the drawbacks, and that it would help to boost inflation towards the Bank’s 2pc target.

What we can learn from a short history of sub-zero rates
What we can learn from a short history of sub-zero rates

“Since it has not been tried in the UK, there is uncertainty about this judgement, and the MPC is not at a point yet when it can reach a conclusion on this issue,” said Mr Vlieghe.

“But given how low short-term and long-term interest rates already are, headroom for monetary policy is limited, and we must consider ways to extend that headroom.”

The policymaker said unemployment could rise because the pandemic has forced the economy to change, with businesses and consumers behaving in new ways.

But it is not yet clear whether these changes, such as extra online shopping and large-scale working from home, will persist permanently.

As a result companies are reluctant to hire and invest to build up these new lines of business, leaving workers in the lurch between their old jobs and potential new careers.

“Firms in expanding sectors will be less willing to invest and hire if they do not know to what extent the strong demand in their sector is temporary or permanent,” he said, adding that in August the Bank of England predicted unemployment would rise to 7.5pc - equating to roughly the same number of people who lost their jobs in the financial crisis.

“That in turn means that new employment and new investment in expanding sectors might not be strong enough to offset a reduction in employment and investment in declining sectors.”

Three-tier Covid lockdown map
Three-tier Covid lockdown map

All of this is not enough to convince Mr Vlieghe that the Government should stop restricting economic activity.

To the contrary, he said that measures to suppress the virus should ultimately help the economy because it was Covid that was largely to blame for people staying at home and not spending.

“Government restrictions... matter a lot. They help suppress the virus  and suppressing the virus is good for public health and good for the economy,” he said.

“But good for the economy is a subtle concept here, because it means good relative to a scenario where the virus is not suppressed, which would result in a lot of economic damage.”