The topic of negative interest rates has been hanging over the Bank of England like a bad smell for quite some time.
Negative interest rates sound weird, but they mean exactly what they say. If you’re a saver, you get charged for the privilege of lending money to your bank (ie keeping it in a bank account). If you’re a borrower (or an ordinary one at least) – ah, well not so fast.
The occasional lucky person in Denmark now gets paid to borrow money to buy a house, but Denmark has had negative rates since 2012. I can guarantee you that if they were introduced in Britain, you’d be getting charged on your savings from day one, whereas you’d be waiting a lot longer – maybe forever – to get paid on your mortgage.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
So it’s a good thing that they’re highly unlikely to ever arrive here.
Why central banks are like superstar footballers (they wish)
The topic of negative interest rates won’t go away. It’s not entirely clear what they do that printing money can’t do in a less disruptive manner, and it’s not clear that they’ve done much for the countries that have implemented them (Denmark, Sweden, the eurozone and Japan) other than suppress their currencies. That can be a useful side-effect – but it’s hardly something the UK needs right now.
So there’s an argument for dismissing them out of hand. There are other tools in the tool box. Why does the Bank of England even need to keep coming back to the topic?
However, it’s not that simple. Markets price in expectations for the future. So the Bank needs to worry about managing those expectations as much as it needs to worry about the actual operations it conducts. In fact, playing mind games with the market is the biggest part of any central bank’s job.
Mervyn King (who arguably wasn’t great at this side of market management while he was in charge of the Bank) had a famous football analogy all about this. I’m not that interested in football, so my summation may lack poetry, but King talks about Diego Maradona managing to convince all the defenders in his path that he’s going to go left, then right, and then he just runs straight down the middle and scores.
Mario Draghi was the master of this stuff when he was at the European Central Bank – it’ll be interesting to see if all that geopolitical poker playing experience pays off for him while he’s running Italy.
Anyway, the point is that you have to convince markets that you’re ready for all eventualities, and also that you’re not taking your eye off the ball. Say the Bank just turns around and says: “Negative interest rates are off the table”. Markets will immediately interpret that as a hawkish sign. In other words, they’ll view the dismissal of the tool as a sign that the Bank is thinking about tightening monetary policy.
So the Bank has to at least keep the option open. That’s why it said yesterday that the banks should prepare themselves for negative interest rates to be imposed in six months’ time. But it won’t actually do it unless it needs to. And it doesn’t think it will need to, because when you look at the Bank’s forecasts, it turns out that it expects the economy to make a solid comeback in the second half of the year. As Chris Giles notes in the FT, the Bank “expects the recovery to make up any loss of output in the first quarter by the end of the year”.
Even with all this equivocation, markets took this as good news. The pound shot up, having been weakening against the dollar in the morning. And gilt yields headed higher too (when gilt yields rise, it’s a sign that markets are more bullish on economic prospects).
In short, the Bank wants to keep negative rates on the table, as much so it can threaten markets with the idea as actually commit to it. But unless something really surprising happens (I accept that this can’t be ruled out) then it won’t be using them.
There’s an easy way to bet against negative rates
As an investor, if you agree that it’s unlikely that negative interest rates will ever be an issue in the UK, then one way to bet on that outcome is to invest in the banks. Banks don’t like negative rates. The main reason – or the one that’s cited most regularly – is because they make their profits from the gap between the rate at which they borrow money from the market, and the rate at which they lend it to customers.
Don’t get me wrong. You still make a profit if you borrow at a very negative rate and then lend at a slightly less negative rate. But the fact that rates have turned negative implies that the economy is doing badly. That in turn implies that the yield curve (the gap between short-term and long-term interest rates) is going to flatten. That means that the profit margin to be had by borrowing at a long-term rate and lending at a short-term one is going to be squeezed.
So that’s one reason that negative rates are bad for banks. The other reason is a bit more prosaic, but one that I think is perhaps under-emphasised. And that’s the fact that most banks don’t really seem to be ready to implement negative rates. That would mean faffing about with back-office systems and bits of IT that are already causing many high street banks the occasional embarrassing tech problem.
I’m not suggesting for a moment that negative rates would be a Y2K moment for traditional banks, but let’s be honest here, they’re not exactly up there with Amazon when it comes to their digital customer service.
Anyway. Long story short, if you agree with the Bank of England in that you think that negative rates won’t be needed here, and that the UK economy is going to do pretty well once the vaccine is rolled out, then sticking some money into the banks seems a good play on that.
We’ve mentioned Lloyds (LSE: LLOY) a few times here (full disclosure: I own it myself), and it was one of Jim Mellon’s favoured picks in his recent interview with Merryn (nicely timed, it came out literally before the first vaccine good news broke). However the others will benefit just as well, so I wouldn’t worry too much about buying specific ones, just get exposure to the sector.
We’ve looked at ways to play this and the wider rebound in the UK economy in MoneyWeek regularly over the last six months or so, and we’ll be looking at it again. Get your first six issues free here if you haven’t already subscribed.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
M&S shares look fabulous as pre-tax profits are up by 56%
M&S is performing strongly and has announced it will pay a dividend for the first time since the pandemic.
By Dr Matthew Partridge Published
The rise and fall of Sam Bankman-Fried – the “boy wonder of crypto”
Why the fate of Sam Bankman-Fried reminds us to be wary of digital tokens and unregulated financial intermediaries.
By Jane Lewis Published
Halifax: House price slump continues as prices slide for the sixth consecutive month
UK house prices fell again in September as buyers returned, but the slowdown was not as fast as anticipated, latest Halifax data shows. Where are house prices falling the most?
By Kalpana Fitzpatrick Published
Rents hit a record high - but is the opportunity for buy-to-let investors still strong?
UK rent prices have hit a record high with the average hitting over £1,200 a month says Rightmove. Are there still opportunities in buy-to-let?
By Marc Shoffman Published
Pension savers turn to gold investments
Investors are racing to buy gold to protect their pensions from a stock market correction and high inflation, experts say
By Ruth Emery Published
Where to find the best returns from student accommodation
Student accommodation can be a lucrative investment if you know where to look.
By Marc Shoffman Published
Best investing apps
We round up the best investing apps. Looking for an easy-to-use app to help you start investing, keep track of your portfolio or make trades on the go?
By Ruth Emery Last updated
The top funds to invest in - November 2023
Tips Investors are focused on income strategies and FTSE heavyweights. We look at what investors have been adding to their portfolios in the last month
By Vaishali Varu Last updated
The world’s best bargain stocks
Searching for bargain stocks with Alec Cutler of the Orbis Global Balanced Fund, who tells Andrew Van Sickle which sectors are being overlooked.
By Andrew Van Sickle Published
Revealed: the cheapest cities to own a home in Britain
New research reveals the cheapest cities to own a home, taking account of mortgage payments, utility bills and council tax
By Ruth Emery Published