It’s the reality of an interest rate cut that concerns me.
Tony Ward is chief executive of Clayton Euro Risk
Will he or won’t he? So much speculation in the press this week about whether Governor of the Bank of England, Mark Carney, will cut interest rates in the next few months. The conjecture comes on the back of the speech he made last week in which he hinted at the need for fresh economic stimulus and the likelihood of ‘some monetary policy easing’ in response to the Brexit vote.
Many analysts suggest that a 0.25% drop is the most likely scenario in the short-term, with the possibility of further quantitative easing. Some even go so far as to predict that the base rate will be cut to zero by the end of the summer as investors flee to safe havens.
And yet, and yet….
Carney’s performance post-Brexit has been masterly: his calm and composed demeanour when he appeared on the morning-after-the-night-before undoubtedly played a key role in soothing the markets’ fears, albeit the £250bn of promised additional funds doesn’t seem quite enough to me . By hinting at an interest rate cut, he has further demonstrated his willingness to take decisive action and do what must be done. In that respect, it’s been an effective move. But it’s the reality of an interest rate cut that concerns me.
I feel uneasy about this policy. The European Central Bank’s chief economist Peter Praet has warned that this type of economic stimulus in the eurozone may soon risk undermining the profits of the continent’s banks. The ECB board member said that banks had passed on lower interest rates to their customers because of competition: “In a relatively narrow market where there is still overbanking, you compete for the few customers that you have,” he said. But Mr Praet warned that ‘at some point banks may start to not pass on these conditions’. That time, he declared, is approaching.
There is a school of thought that as central bank interest rates decline, and commercial lenders attempt to pass them on to savers, there will come a point at which consumers cease to make deposits at high street banks. If rates of return fall too low, it is believed that these depositors will start to withdraw their money from the banking system altogether. In this case, interest rate cuts would cease to stimulate the economy, and could instead have the opposite effect. The chief economist said that he believed the sell-off in European banking stocks since the UK’s referendum on EU membership revealed that investors were concerned about the profitability of the sector. He pointed out that the largest movements had been in the shares of lenders, rather than in the bonds they have issued, which Mr Praet concluded ‘reflected earnings’, which it is believed could fall after the Brexit vote. Good point.
Mr Carney himself is no doubt aware of these risks. He stated: “As we have seen elsewhere, if interest rates are too low – or negative – the hit to bank profitability could perversely reduce credit availability or even increase its overall price.”
My view? I’d rather the Bank watch and wait; but if they do make any move, they restrict it to a 0.25% drop. They only have half a percentage point – effectively only two bullets left in the gun - with which to play and I’m not sure it would make much difference. Those countries with zero rates or even negative rate policies have demonstrated that this course of action has failed to kick-start their economies. A cut in rates is supposed to stimulate spending but with rates at zero, the risk is of negating this. Research by Merrill Lynch shows that households in Denmark, Sweden and Switzerland – where rates are negative – are now saving more as they worry about future income.
A cut in rates? It may send a message to the markets that the Bank remains firmly in control, but it’s not the be all and end all. Not a panacea by any means.
