MNI INTERVIEW: BOE To Cut To Negative-Ex Official Aikman

The Bank of England is likely to cut rates to negative levels, David Aikman, a former technical head of division on the financial stability wing at the Bank, told MNI.

The BOE has been consulting with banks and building societies over how ready they are to implement negative rates but Aikman, who last year moved from the bank to become professor of finance at King's Business School, does not expect the exercise to reveal road blocks.

"The Bank is rightly engaging with banks and building societies to understand their operational readiness moving Bank Rate to zero or a negative number …(but) I don't expect it to throw up intractable technical problems," Aikman said.

Aikman said it is a mistake to think that BOE Governor Andrew Bailey and some of his colleagues on the Monetary Policy Committee have been floating the idea of negative interest rates in order to talk the market rate curve lower without intending to follow through.

"The MPC is not talking up the prospect of negative rates to push parts of the yield curve negative so that it need not have to go through with setting a negative Bank Rate. Markets are sophisticated and wouldn't view such a strategy as credible," he said.

TIERING

UK banks are relatively less reliant on household deposits for funding than their eurozone counterparts, which research suggests means they will see less of a squeeze on net interest margins from negative rates. Household deposits account for some 19% of the UK banking system's liabilities compared with 30% in the euro area banking system, according to data Aikman cites.

It is unrealistic to assume that interest rates on household deposit could turn negative and small banks and building societies, which rely on them more, would see a larger hit to margins than the bigger banking groups which have more diversified funding, but Aikman sees technical solutions to this problem.

"The good news is that there are some options available for the bank to mitigate this effect. The first would be via an extension of its Term Funding Scheme, introduced in August 2016 and which basically provides subsidised funding for financial institutions," he said.

The interest rate on term funding could be aligned with the negative rate and funding amounts made available in proportion to each institution's household deposit base.

Another solution is tiering, deployed by the European Central Bank and the Swiss National Bank, which shields small retail depositors by allowing banks to hold fixed amounts of reserves at the central bank at zero return.

"These schemes wouldn't need to differentiate between banks and building societies per se – rather they are targeted subsidies that try to address the profitability implications directly," Aikman said.

Aikman believes that negative rates are complimentary to quantitative easing.

QE's impact is "greatest when asset markets are dislocated as they were back in March last year. Negative rates operate mainly through cash flow effects, so there are reasons to expect the impact on demand to be more durable," he said.