Why negative interest rates are a lousy idea

The Bank of England’s governor, Andrew Bailey, should avoid pushing rates below zero

(Image credit: © ANDY RAIN/EPA-EFE/Shutterstock)

published 22 October 2020

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The economy is relapsing, says The Observer. The Bank of England has pumped £300bn of quantitative easing into the system this year, but as the second wave of Covid-19 gathers pace all the signs are that it is not enough. UK consumer price inflation was just 0.2% in August and banks have tightened lending criteria.

That means that it’s time for negative interest rates. The Bank’s governor, Andrew Bailey, says evidence from Europe shows negative rates can encourage corporations to invest rather than just stashing cash in the bank. Right now, the economy “needs all the help it can get”. UK interest rates currently sit at 0.1%, with financial markets pricing in a shift into negative territory next year. The Bank of England is conducting preparatory work, with Bailey describing the policy as being in the “toolbox”.

The Bank would use the rate to penalise commercial banks that deposit excess reserves with the central bank, says The Times. It wants them to lend the money instead. Banks would probably avoid passing on negative rates directly to depositors and those with mortgages should not anticipate a payday. The policy would “probably be a mistake”. Lenders want their money back and in a steep downturn there are fewer creditworthy borrowers around. When the economy is weak no amount of interest-rate prodding will make the banks lend more.

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These are bad times to be a saver, says The Economist. America’s one-year Treasury bill, a traditional way of storing cash, yields just 0.13%. “It would take more than 530 years” to double your money by reinvesting that interest. Today’s savers have three options: save less and spend more; save more to compensate for lower returns; or put their cash into riskier investments, such as shares. Central bankers generally assume that lower interest rates cause the first reaction, but the data is much less clear. As is “already happening in Japan”, the old increasingly “risk running out of money before they die”.

Negative interest rates are a “terrible idea, smacking of desperation”, says Liam Halligan in The Daily Telegraph. They are also “deeply counter-productive”. Pension funds are forced into “risky, speculative investments” in a desperate hunt for yield. The experience on the continent shows that banks avoid cutting interest rates on deposits, thus weakening their balance sheets and making the whole financial system more fragile. The winners are those with a vested interest in seeing “massively bloated” stock and bond markets surge even higher. The economy is already in a “ghastly situation”, we don’t need to make it “even worse”.

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.