BoE on the way to negative interest rates

Bank of England
Date: 22 October, 2020 - Blog

It is not currently the main scenario case, but negative rates are possible in the UK next year if Brexit goes badly or if Covid-19 gets worse. While the BoE has made it crystal clear now that negative rates are part of its toolkit, it has opted to take time to analyze the potential impact. This is unlikely to be complete before the November meeting, but we could not totally rule out such a move. The major focus will be on QE, and that will give policymakers time.

The BoE will lower rates further next year. Even if the economic outlook does deteriorate further, the Bank will need to be convinced that negative rates will make a difference. Recent MPC comments suggest there are far from a consensus. The best monetary policy role now is to facilitate the fiscal policy. That said, negative rates could help the BoE to shape markets via forward guidance in future crises. So far, the BoE has successfully pushed market rates below the zero without having to implement the policy. To achieve a similar result in the future, policymakers need to be credible. If the BoE were to implement negative rates in 2021, it would be reluctant to go significantly below zero. We could imagine the MPC would be keen to exit the policy quickly, like Sweden Riksbank did at 2019-end.

Negative rates would not come as a great surprise

The forward market has been below 0% since June, showing persistent expectations from a large investors’ basis. This also reduces its impact. It will push 10-year UK gilt yield below 0%. It would be unsurprisingly negative for GBP. A no Brexit deal could be a trigger for negative rates, but in this scenario, we could expect it to be more GBP negative. As EUR/GBP is more sensitive to interest rate differentials than GBP/USD, BoE rate cuts would be more detrimental for GBP vs. EUR than vs. USD.

Boris Johnson has warned the EU that  talks on a post-Brexit free trade agreement are over, unless Brussels shows a fundamental change of approach. He told the UK to get ready for no-deal. Johnson accused the EU of making unacceptable demands. There are chances that the EU and UK relation will be done under the WTO standard trading rules.

  • Chances of a deal, or a large deal, are decreasing
  • Short-term pain for the GBP will continue


Jerome Baillaud