February 26, 2013 7:55 pm

Few support BoE option of negative rates

A world of negative interest rates would mark a radical departure. In the most extreme form of the policy, if you were to deposit a tenner into a bank rather than under the mattress, you would find subsequently you had less than £10 available for withdrawal.

Such a system would offer large incentives to spend money or hoard cash in piggy banks rather than commercial banks.

Even though Paul Tucker, deputy governor of the Bank of England, caused excitement by discussing “negative interest rates” in evidence to MPs on Tuesday, it is a policy option that has few supporters at the BoE.

Mr Tucker was facing persistent questioning on the subject and did not make himself entirely clear. It was not a case of a central banker musing about an abstract idea as a signal of its imminent implementation, BoE officials said subsequently.

Ever since official interest rates fell to 0.5 per cent in early 2009, the central bank has regularly considered the case of dropping them further, even to a level below zero. But it has always dismissed the idea.

The most recent view of the Monetary Policy Committee on the subject was contained in the minutes of its latest meeting. After listing a series of policy ideas including lowering official interest rates, the MPC concluded: “The committee noted drawbacks with each of these options in the past; those drawbacks remained”.

Negative interest rates is far from a simple concept.

The first option would be to lower the official short-term interest rate, known in the BoE as bank rate.

This is deeply problematic, officials agree, because the move would immediately hit the revenues of banks who still have many mortgage products linked to official interest rates and who might not be able to lower interest rates on deposits any further.

Such a policy, designed to boost growth, would hurt banks and might, in the extreme, put them out of business, which would have the opposite of its intended stimulative effect.

Instead, when other negative interest rates have been considered in other countries and have been occasionally implemented, such as in Sweden in 2009, the policy has been more subtle. The negative rate has not applied to the official interest rate, but to the rate of interest the central banks themselves pay on the reserves that banks park in their coffers.

The idea behind imposing negative interest rates on a portion of banking reserves, effectively charging banks rent to hold money at the BoE, is that banks will lend more in order to compensate for what in effect amounts to a tax levied by the central bank.

Sir Mervyn King, governor, suggested the BoE was considering reducing the interest it pays on reserves in 2009. Since then, however, the BoE has cooled on the idea, noting in this month’s minutes that problems highlighted last summer remained.

In the minutes of the June 2012 monetary policy meeting, the MPC said there was “a large degree of arbitrariness” in cutting the interest paid on reserves at a time when the amount of cash parked at Threadneedle Street far exceeded historical norms and the policy would confuse money markets.

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