Comment

Negative rates will send us through the looking glass

Far from mending our economy, sub-zero rates will only boost bloated stock and bond markets

The Bank of England is seriously investigating the possibility of driving interest rates into negative territory. There’s no plan to actually do this, we’re told – it’s about “having the option in the policy toolbox”.

Last week, though, our central bank began talking to the Prudential Regulation Authority about how negative rates might be implemented later this year, with the PRA writing to banks themselves asking how they would cope. Something could soon happen.

We must hope UK interest rates aren’t yanked below zero, taking us into some kind of Alice in Wonderland world where companies and households are paid to borrow and charged if they save.

That would be a terrible idea, smacking of desperation, a placing of perceived short-term relief over long-term credibility.

For the international evidence is clear. Negative interest rates don’t generate growth but do cause yet more financial instability while provoking international tension. They are deeply counter-productive, while rates are already at a 0.1pc record low – and the only argument for them is that “something must be done”.

Financial markets are obviously obsessed with the reported rise in the incidence of Covid in many countries and resulting lockdown measures – as winter approaches.

No matter that in the UK, for instance, while daily “cases” are up threefold since this pandemic peaked in early April, we’re doing more than 10 times as many daily tests.

More lockdown is coming, and that would slow, if not reverse, the broadly V-shaped global recovery seen since the pandemic-induced slump of March and April.

So, even if there’s no second wave in terms of fatalities, “Covid Two” will seriously impact global markets heading into 2021.

This summer’s recovery sprung not just from pent-up demand, but also a quite unprecedented policy stimulus.

Across the world, governments unleashed an estimated $12,000bn (£9,300bn) of public spending, while central banks expanded their balance sheets by $7,500bn. This combined push to reverse a global depression amounted to over 20pc of last year’s worldwide GDP.

Now another global slump looms, as renewed lockdown takes hold. But this time public sector debt levels are already above 100pc of national income across the major economics. Our central bank virtual printing presses are already cranked up.

The IMF, in last week’s Global Financial Stability Report, noted that company insolvencies are spiralling upward. Under particular pressure are small and medium-sized enterprises – which, across the world, employ the vast majority of people.

As budget deficits widen and government balance sheets groan, central banks are – once again – coming under pressure to implement ever more extreme monetary policy, as politicians wince at the prospect of mass unemployment and a possible financial collapse. Negative interest rates, though, are not the answer. They would make a ghastly situation even worse.

Six years into the global negative rates experiment, we know they do more harm than good. Searching for new ways to boost growth, some central banks stepped “through the looking glass” back in 2014, setting rates below zero.

The European Central Bank went first, followed by Sweden and Japan.

Private sector banks in these jurisdictions were forced to pay their central banks to keep their money on reserve. Penalising cash on deposit, negative rates were supposed to jolt spending and encourage banks to extend loans, bolstering broader growth.

In reality the policy squeezed banks ­– given their reluctance, fearing mass deposit withdrawal, of passing negative rates on to front line customers.

So bank balance sheets weakened, making them more unstable, and less willing to extend loans. Across the eurozone, as in Japan, countless smaller, regional banks, so important for on-the-ground commerce, have cut lending.

Along with pension funds and life insurance companies, they’ve been forced to shore themselves up by “searching for yield” – given the now deeply negative returns on government bonds and other fixed income investments such institutions need. And that’s driven yet more “mainstream” cash into risky, speculative investments.

So negative rates don’t encourage growth.

But they do encourage banks to channel even more money into speculative activity, investment which plays no role in the financing of regular business activity that creates jobs and generates broader recovery. And that what this is really all about.

Large financial institutions want negative rates to, once again, boost stock and bond markets that are already massively bloated. Cowed into submission, politicians and central bankers will no doubt give them want they want.

Far from mending our economy, quantitative easing and ultra-low rates could provoke another crash. Even more QE and negative rates make such dangers more acute still.

And, on top of all that, negative rates fan the flames of international tension – given that a big reason central banks use them is to grab competitive advantage via resulting currency depreciation.

As if there wasn’t enough going on in the world, we’re now in danger of sparking a renewed outbreak of the currency wars – a direct descendant of the notorious beggar-thy-neighbour devaluations of the Thirties.

Back then, currency conflicts contributed to a disastrous deterioration in relations between trading rivals. Today, while we’re some way from global conflict, protectionism is on the rise – and negative rates won’t help one bit.

The biggest immediate problem with negative rates, though, is that the policy is so weird and unnerving that it could be actively discouraging the run-of-the-mill private sector investment we need to get the UK and other big Western economies back on track.

Utterly bemused by ever more extreme monetary policy, many business bosses across the country will be spooked completely if we venture even further down the monetary rabbit hole by introducing negative rates. And that’s before we launch so-called “helicopter money” – with the authorities putting newly created cash directly into every citizen’s bank account. Really – such measures could soon be on the cards.

“It would be so nice if something made sense for a change,” says Alice, in Lewis Carroll’s classic. The same goes for 21st century central banking.