Bank of England mulls negative interest rates

Paul Tucker, deputy governor for financial stability, raised the possibility in front of MPs after saying the Bank could be doing more to help the economy, including measures to boost lending to small businesses.

Negative interest rates would mean high street lenders paying the central bank to place their money with it. The move would be intended to encourage more lending to businesses and households. But it could also lead to a reduction in the interest paid on individual savers’ accounts held with high street banks.

The Bank has considered cutting rates from their record low of 0.5pc in the past but decided against doing so for fear of bankrupting a number of smaller building societies. To get round the problem, the Bank is reviewing a possible change to its remit so it can set a separate interest rate specifically for excess deposits placed by financial institutions at the central bank.

Addressing the Treasury Select Committee, Mr Tucker said: “I hope that we will think about the constraints of setting negative interest rates. This would be an extraordinary thing to do and it needs to be thought through carefully.”

Malcolm Barr, an economist at JP Morgan, said the proposal “sounded more in the space of providing blue-sky options than something he was pushing for implementation of in the near term”.

Other central banks, such as the European Central Bank, have two rates – a base rate and a deposit rate. In the UK, Bank sources said, a new so-called deposit rate could be charged on funds placed with the central bank above a certain level. For example, the first £1bn of banks’ money held could be charged at the existing base rate, and the rest at the new ‘deposit rate’.
When Denmark introduced negative rates for the first time in its history last year, it was the deposit rate that was cut below zero.

The distinction would protect building societies, which derive much of their income from base rate tracker mortgages. As they cannot cut their savings rates much lower, if base rates were reduced they would be unable to claw back the lost mortgage income and could potentially go bust.

Speaking to MPs, Mr Tucker also claimed the Bank could be doing more to help small businesses, which he described as the lifeblood of the economy. He said: “I am worried that our current policies may not be reaching as far into the SME [small and medium sized enterprises] sector as we would like.”

He suggested extending the Funding for Lending cheap credit scheme to non-bank lenders, such as insurers, and raised the prospect of new policies to ensure small businesses had sufficient access to vital working capital. “I find it regrettable that the markets for working capital finance are not as good as they were a decade ago. The Bank could play a role,” he said.

At the start of the decade, small businesses could raise working capital finance by issuing lines of credit that were able to be swapped with the Bank for cash. Although the arrangement remains open, other changes have made it less attractive for companies to accept the credit lines – making small businesses almost entirely dependant on banks for any form of loan.

The Bank’s new-found willingness to consider radical alternatives to QE comes in the wake of Mark Carney’s appointment as Sir Mervyn King’s successor as Governor. Mr Carney is expected to shake up policy when he arrives in July and senior Bank figures said the fact that a range of ideas are already being considered shows policy is “not stuck in the mud”.

Mr Tucker also stressed that “nobody on this [rate-setting] committee thinks that QE [quantitative easing] has reached the end of the road”.

Mr Tucker and his fellow rate-setters also told MPs that the Bank has been operating a “flexible” 2pc inflation mandate that allows it to get back to target over a variable timeframe, like the one proposed by Mr Carney, since 2004.

Addressing the UK’s sovereign credit rating downgrade by rating agency Moody’s, Charlie Bean, the Bank’s deputy governor for monetary policy, added that “other agencies may follow suit”. But he said markets were expecting the move: “I don’t regard it as having an awful lot of news in itself.”