Anderson HarrisMarket Insight
Why so Negative?
Published: 18th June 2020
This Article was Written by: Harry Arnold
A Long Road
Today the Bank of England announced that it was expanding its quantitative easing programme and pumping a further £100bn into the UK economy, no small change, however, the Bank has already stated that expanding its bond-buying programme remains the primary way it will look to do its part in the fight against Coronavirus.
It also announced that it was keeping rates at 0.10%, however, if expanding the money supply does not get the job done will the next step be for the Bank to take us in to the undiscovered country, a new frontier where commercial banks will need to pay to place cash at Threadneedle Street and where in theory you could be charged to leave your money with the Bank and be paid to borrow from it? Such a decision would reverse the polarity of the UK Banking system and fundamentally change how we understand how banking works. So why go negative and what would it mean for you?
The stated role of the B of E is to target a 2% inflation rate (price rises) in the UK economy and more broadly to assist the UK government in supporting growth and employment. In short, if prices are rising you are encouraged to buy now rather than wait for them to drop down the road, this in turn helps drive activity (buying products and services) which helps support growth (GDP) for UK business, providing jobs, higher wages, more spending power for the consumer and tax revenue to fund public services. This stable and manageable level of inflation only erodes the buying power of your pound slowly and in theory the incentive for the consumer to buy now as opposed to later increases your wages faster than inflation erodes it. The virtuous circle is completely correct?
Central banks don’t control prices. The cost of capital and how easy it is to access it when you want it to buy a house, a car or someone to cut your hair is the way that the Bank affects prices. If it’s cheap and easy to borrow then prices rise as more affordable capital is available to buy, as credit becomes more expensive prices cool off as people choose not to pay for expensive capital to buy things. This delicate balance is what drives monetary policy in a capitalist world.
Why so Negative?
The current position is that the economy needs help, a lot of help. It is impossible to sell your wears when people can’t leave their homes, for now in large part the government is paying. In April this year the UK government borrowed more (£63bn) than it was expected to borrow in the whole of 2020 (£53bn) as outlined in the budget back in March, that is before a huge expected drop off in tax revenue from lockdown and the upcoming recession, government debt is rising and here to stay. When the government emergency taps slow to a trickle in the autumn, consumer confidence will remain low, however business will need a market to trade in to survive. With people valuing their health over their ability to buy some new shoes, economic activity is expected to remain a damp squib until a vaccine or treatment are available. The threat to wages and asset prices also pushes down confidence and alters our economic behaviour, we watch what we spend. This means we need to be encouraged to be as economically active as possible, pushing up demand and supporting future jobs and wages, que the PM standing in front of a Primark asking to do their bit and go shopping. If we don’t and too many goods chase too little money, prices start to fall, entering a period of deflation. If prices fall you hold off from buying things until they are cheaper in the future, this drives lower activity and helps the economy recede further, forcing business to cut jobs, creating lower wages and less tax revenue for a public sector that requires more, not less funding.
Policy makers at the Bank believe that negative interest rates could be the vaccine to the virus of deflation. If you force banks to lend money by making it unattractive to hold deposits, they can pass this cheap credit on to consumers, encouraging them to spend. Equally if you collapse interest rates further savers are more likely to look at turning those savings in to other more economically useful assets, like a new kitchen for their home or investing in a new business, even better they could buy those new shoes. Such is the grip of economic fear that Marcus by Goldman Sachs, which has one of the leading high interest savings account on the market had to close itself off to new customers, as they had nearly reached their £25bn limit for deposits. For the economy that £25bn would be far better served being spent in you buying a flat white in Pret or a pie and a pint from your local watering hole.
OK, ok, but why does this matter to me?
Cheap (or free) credit allows people to borrow to buy, but if the prices of the things they buy (houses being a prime example) become artificially high from the cushion of cheap money, bubbles can be created, the cheap credit can distort the real value of something. Coupled with measly attempts to increase the housing supply, many argue the current longstanding housing crisis has been created in large part by the Bank of England’s decade spanning policy of sub 1% rates. This has acted like jet fuel for housing, raising values above the means of those who have not been able to access cheap capital (either from commercial banks or the bank of Mum and Dad) to buy. These bubbles are dangerous when relating to property as leveraged purchases are doubly affected when bubbles burst (see US subprime mortgage crisis). Cheap and easy money can often be bad money.
If Banks do end up being charged to deposit money and paid to lend it is very unlikely that you will be charged to hold deposits. The natural response to remove cash from accounts and store them under your pillow as bank notes would be deeply impractical and the removal of capital from the system would create a whole new set of problems (UBS in Switzerland with a base rate at -0.75% only charges interest on deposits over 2m CHF to the wealthiest customers). On the other side however we have seen Jyske Bank in Denmark pay 0.5% on certain mortgage deals, the customer pays back less than they have borrowed, not more. Could we see this oddity in the UK? The need to guard against a deflationary spiral is mission critical, but there are long term risks to reversal of the almost universally understood principle that borrowing money costs and saving money makes. This polar shift could increase private debt to not seen before levels, leaving us with little to no personal liquidity, it could also be very difficult to go back on. This is probably why they won’t bother.