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Bearish Risk

MNI INSIGHT: BOE Tiering Likely To Lag Negative Rates

If it cuts below zero, the BOE is likely to introduce refinements such as tiering only gradually.

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The Bank of England looks set to announce next month that UK banks should be able to withstand negative rates, but varying levels of preparedness within the financial system could mean that any swift subsequent cut below zero might initially be unaccompanied by refinements such as tiering.

The European Central Bank and the Swiss National Bank have eased the impact of negative rates on net interest margins by continuing to pay higher rates on portions of banks' reserves. But in the UK problems including overhauling some banks clunky IT systems might mean that tiering, together with variations in term funding rates, are phased in incrementally.

With BOE Governor Andrew Bailey having broken with predecessor Mark Carney to say negative rates are an option, it would be uncomfortable for the Bank to turn around next month and declare them to be unachievable. Market curves are already pricing them in.

But UK banks report being at differing stages of readiness. Late last year, executives' responses to the Treasury Select Committee varied from declarations that their systems were fully ready to handle negative rates to claims that they would need up to 18 months to update legacy technology systems.

The BOE is set to publish the findings of a consultation launched in October on banks' ability to cope with negative rates on Feb. 3, the date of the next Monetary Policy Report. It remains an open question whether these will be published in the MPR or in a separate document from the Bank's regulatory arm, the Prudential Regulation Authority, which has done the detailed consultation work.

DIFFERENCES WITHIN THE MPC

Publication by the PRA would put more distance between the analysis of banks' concerns and the monetary policy decision-making process. In that case, the MPC could also provide a separate analysis of the economic case for negative rates, which may be easier for its members to agree on.

There are well-known differences between MPC members on the wisdom of going negative. External members Michael Saunders, Silvana Tenreyro and Gertjan Vlieghe are proponents of the measure, while internal member Dave Ramsden has been more cautious.

BOE Deputy Governor and CEO of the PRA, Sam Woods, told the TSC this month that consultation responses from banks varied considerably and that it "is rather less straightforward to do it for retail customers than it is for wholesale or corporate."

If the MPC wants negative rates as a viable tool the PRA could pressure banks to dedicate the staff and funds needed to bring their systems up to speed fast. That, however, would entail taking personnel and resources away from other areas, including ones that may also concern the PRA.

The MPC may have to trade off complexity against speed on negative rates. Either way, it is likely that going sub-zero is a task the BOE has to undertake in stages, with an initial cut in the headline rate followed only later by mitigating measures.