MNI INSIGHT: Banking Changes May Mean UK Rates Could Go Lower

-BOE MPC Members Stick To Line That Zero Lower Bound Is Just Positive

-But Detailed Research On Topic Dates Back To June 2016 Stimulus Package

By David Robinson

     LONDON (MNI) - The Bank of England maintains that setting a negative policy

rate would be counter-productive in the event of a steep slowdown, but changes

to British banking might have shifted the so-called lower bound of interest

rates since the last detailed work to calculate its location more than three

years ago.

     While central banks elsewhere have implemented negative interest rates

without obviously perverse effects, the differing structures of national banking

systems can affect the level of the lower bound, with some better able to

withstand very low interest rates than others. In its last examination of the

matter following the June 2016 vote to leave the European Union, the BOE

concluded that factors including a potential squeeze on bank margins meant that

it could push rates no lower than around 0.1% even in an emergency. The BOE cut

to 0.25% in the wake of the referendum, later increasing Bank Rate to 0.75%.

     But there have been plenty of changes in bank lending since 2016. A note

last month by BOE economist Fergus Cumming highlighted how a surge in fixed-rate

mortgages has resulted in typical borrowers waiting around three years for

interest payments to adjust to changes in Bank Rate, compared to around a year

before the 2008 financial crisis.

     Similarly, recently-issued policy rate tracker mortgages have had interest

floors inserted to protect lenders' margins if Bank Rate were to move towards

zero or below. While bank shares still tend to fall on a rate cut, suggesting

investors still expect a squeeze on margins, these changes could mean the

reversal rate -- that at which accommodative monetary policy reverses its effect

and becomes contractionary - is edging down.

     Another constraint on the lower bound is posed by the increased

attractiveness of cash once negative rates effectively impose a charge on

holding bank deposits. Economists argue that a point comes at which savers and

companies find it cheaper to pay for the cost of holding paper cash in vaults.

     --SWEDISH EXPERIENCE

     But Stefan Ingves, governor of the Riksbank, which cut its repo rate to

-0.5% from 2016 and held it there until October 2018, said the danger of a

flight to cash had been overstated, and that the Riksbank could have cut by more

if necessary and still added stimulus.

     "-0.5% certainly was not the zero lower bound," he said Tuesday at a Money

Macro and Finance Society event, noting that the costs of holding cash,

including insurance and transportation, meant that savers would be more likely

to put up with negative rates.

     Bank of England MPC member Jan Vlieghe said at the same event that he

remained of the view that the effective lower bound was close to, but above,

zero. He agreed with Ingves that maintaining banking profitability was a more

important factor than the relative attractiveness of cash over deposits in

determining the lower bound.

     Vlighe said the level where profitability is hit "depends very much on the

balance sheets of the financial institutions in your country and, in particular,

how they are funded, what sort of assets they have, whether the assets are

indexed to the policy rate or the assets are generally linked to longer term

policy rates."

     "So, to me, it is absolutely no surprise that different central banks in

different economic areas come to a different conclusion about how low it is they

think they can go before they hit that point."

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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