UK interest rates could drop below zero in 2021

The Bank of England could cut interest rates to below zero next year after officials said preparations were under way to allow the central bank to support the economy with lower borrowing costs.

In a move that would bring the BoE into line with the European Central Bank and the Bank of Japan, the monetary policy committee (MPC) said it was seeking to overcome obstacles to negative interest rates that would allow further cuts from the current 0.1% base rate.

Until recently, the central bank’s nine-strong interest rate setting committee has ruled out cutting borrowing costs into negative territory, arguing that it would make mortgage lending unprofitable for many banks and building societies, forcing them into financial difficulties.

The MPC said in its September report that the bank was discussing how to overcome technical barriers and put itself in a position to cut rates further, “in light of the decline in global interest rates over a number of years”.

It said: “The MPC had been briefed on the Bank of England’s plans to explore how a negative Bank rate could be implemented effectively, should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates.

However, there is little likelihood of a cut to below zero this year after it added: “The Bank of England and the Prudential Regulation Authority will begin structured engagement on the operational considerations in 2020 Q4.”

Philip Shaw, a senior economist at Investec bank, said investors expected the central bank to overcome its previous reluctance to use the option of negative rates if the economy worsened in 2021. “A crystallisation of the downside risks would leave the option of a subzero Bank rate as a serious possibility at some stage,” he said.

The pound fell half a percent to $1.29 on the speculation that negative interest were being considered, though later recovered the lost ground.

The committee said the latest data showed that the economic recovery was on track but that the outlook remained “unusually uncertain”.

Health concerns would continue to drag on the economy’s ability to rebound from the coronavirus lockdown and there was still the prospect of a steep rise in unemployment, it said.

The MPC voted to unanimously keep its main interest rate unchanged at 0.1% and to maintain its £745bn quantitative easing (QE) programme, which has increased by £300bn since March.

Most City analysts said they expected the MPC to add a further £75bn to £100bn to its QE programme at its next meeting in November if the recovery from lockdown continues to lag.

In a letter to the chancellor, Rishi Sunak, the Bank of England’s governor, Andrew Bailey, said the MPC had held rates steady despite a sharp fall in inflation in August to just 0.2%.

The governor is required to write to the chancellor each time inflation is one percentage point above or below the 2% inflation target set by the Treasury.

In the letter, Bailey said: “The temporary cut in VAT for hospitality, holiday accommodation and attractions, together with the government’s ‘eat out to help out’ scheme, were expected to lead to a material drop in inflation in August. These effects have transpired.”

He added that inflation was expected to stay low while office-based staff returned slowly to work and local lockdowns restricted economic activity.

But the MPC forecast a rise in GDP during the third quarter of 18%, showing that it remains bullish that a Brexit deal was likely and that the impact of the coronavirus would fade towards the end of the year.

Analysts said the central bank’s officials would be mindful of core inflation, which excludes volatile elements of goods and services in the inflation basket, and remained higher at 0.9% in August.

Andrew Wishart, an economist at the consultancy Capital economics, said the MPC was likely to delay negative interest rates as long as possible after several committee members voiced concerns. “As the MPC is wary of the side-effects of negative interest rates on banks, we think that will come in the form of a further £100bn instalment of QE (consensus £50bn),” he said.

“And in any case, with the MPC today repeating the guidance that it won’t tighten policy ‘until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target’, we expect interest rates to be no higher than 0.10% for the next five years.”