Negative interest rates – is it really bad news?

There has been an awful lot of bad market reaction to Paul Tucker’s comments to the Treasury Select Committee earlier in the week that perhaps banks should earn a negative rate of interest on money deposited with the Bank of England.

He said that a negative interest rate would mean the Central Bank charges banks to hold their money and could encourage them to lend out more of their funds instead of hoarding it with the Bank.

Speaking to MPs on the Treasury Committee, Mr Tucker said: "This would be an extraordinary thing to do and it needs to be thought through carefully."

Banks have been quick to assert that if he does this then the consumers will pay with higher borrowing costs and negative deposit rates.

Why?

What he is suggesting may seem radical but is not as bad as it sounds. In my blog last summer (see http://home-funding.blogspot.co.uk/2012/06/how-central-banks-should-work.html) I talked about the tendency for banks to hoard cash rather than to put it to work as intended by the Bank of England. There is no reason to link Bank Rate (and hence Base Rate) to the rate at which the Bank of England gives on deposits with them. Indeed, couldn't you make a case for banks actually benefiting from the Bank of England’s initiative? If banks and building societies don’t hoard cash with the Bank and lend it out to companies and consumers, then aren’t they going to be earning more than they currently are? I know there is a return on capital issue to take into account but I’m sure banks can work that into the calculation of the correct rate to lend at. Mr Tucker’s ‘blue sky’ suggestion is not as daft as it may at first sound.

We need something to stimulate the markets and shouldn't discount these ideas. We still need a cunning plan to kick-start the market in my view!

Shifting sands

On the face of it the latest unemployment statistics look pretty good.

UK unemployment fell in the last three months of last year while the people in work jumped to a new record. The jobless total fell 14,000 between October and December to be 2.5m.  Total employment was up 154,000, up to 29.7 million. So good news.

So why is it that this is happening while the economy remains so sluggish?

As some analysts suggest, many companies are holding on to staff in the hope that an upturn around the corner. Some are even recruiting although I suspect not on any grand scale. However what is true is that redundancy rates are much lower than in the early 2000’s when growth was much higher.

Worryingly though if the number of people in work is rising and the economy remains stagnant it suggests that the British economy is less productive. So are we heading for a grim place where Britain is becoming a lower wage lower productivity driven economy? Unlike some economists I think not. But what is very apparent is that there is a huge change in demographics going on. Perhaps driven by necessity, more people than ever are becoming self employed or turning to part time employment.  The Office of National Statistics report that between October and December 2012, full time employment was 378,000 higher than in the April to June quarter of 2008, the first quarter of the recession. But part-time work was 572,000 higher compared with the same period.

In the near future I see this trend continuing. Something for economists to consider

Following the lead of the US

So the US economy unexpectedly shrank in the final quarter of last year by 0.1%. Bit of a shocker since this is the first time this has happened since the end of the recession in 2009. The Fed has quite rightly just called it a ‘pause’ due to transitory issues. Certainly it is true to say that the steep drop in defence spending, uncertainty over the fiscal cliff and the effects of the hurricane that swept up the east coast in November combined to hit growth. And these certainly are temporary measures; the US Conference Board acknowledged that ‘one-time factors put the number below the trend’.

I guess it’s interesting to see what the Fed has done about it. For a start it has kept its record low key interest rate between 0% and 0.25%. Furthermore it said that it would continue its $85bn a month bond and mortgage security purchases to support a stronger economic recovery. It said the easy monetary policy ‘will remain appropriate for a considerable time after the asset programme ends and the economic recovery strengthens’. What that says is that we are in for the long game. We are here to give assistance until things go back to normal. That’s what brings confidence back to the markets.

Whilst we are trying to emulate this in the UK I’m not sure we are going far enough. For instance the Funding for Lending Scheme which has done much to assist the mortgage lending market in the past few months is apparent that it is only a temporary measure and has a defined end date. Then what? We need some measures that have some longevity.

Some interesting lessons to learn this side of the pond perhaps…