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Bank of England Prepares for Negative Rates

Posted: Wednesday, October 21st, 2020

Estimated Reading Time: 2 minutes

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November 5th is a big day for the Bank of England (BOE) and GBP traders. Only two days after the U.S. elections and one day after the Federal Reserve’s decision, the Bank of England prepares to ease more.

Just like the European Central Bank (ECB) and other major central banks, the BOE waits to see the U.S. elections outcome first. Next, the impact on the pound via the dollar. Finally, it must act as the case for more stimulus built up.

Can the bank deliver a rate cut to zero in November? Possible, especially in light of the recent talk regarding negative rates.

For a while now, both the BOE Governor and some MPC members introduced negative rates in their speeches. Whenever a central bank does that, it tries to see the market reaction. If you want, a trial balloon to see what happens.

Bank of England

Negative Rates from Bank of England in November?

Unlikely. So far, the bank signaled that it considers it part of the toolbox. Also, it stated that it learns from the ECB experience with negative rates. And, it sees benefits during economic growth but unclear results during economic recessions.

However, market participants know that there is no smoke without fire. Most likely, the BOE keeps the negative rates as a tool to use in the case of a no-deal Brexit.

Should the E.U. and the U.K. not reach a deal, the BOE has something new to deploy. Nevertheless, the need to ease more in November has arrived.

More QE from Bank of England This Year

The consensus formed that the BOE will extend the quantitative easing program by another GBP100 billion. If that is the case, the gilt yield will feel further pressure, threatening to break below zero. Q.E. alone may not be enough to push yields negative. However, a combination with negative rates may do the trick.

The problem with negative rates comes with the precedent it creates. So far, the zero boundary looked like a sacred point. Yet, the ice once broken, it makes the market wondering where the new bottom is?

As such, the biggest risk coming from negative rates is not their implementation. Instead, the signal sent to market participants.

The Swiss National Bank (SNB) has the lowest level of interest rate in the world – negative -0.75%. Also, the ECB keeps the deposit facility rate at -0.5% for several years now. Therefore, a move to -0.25% from the Bank of England may be viewed as just a checkpoint on the way lower. How does one know that the BOE stops at -0.25%, say, Brexit ends up in a mess for public finances and the pound?

Central banks setting monetary policy for their fiat currencies know that trust is the true asset they hold. Once broken, the market smells blood immediately and acts accordingly.

Perhaps it is time for the Bank of England should remember the Exchange Rate Mechanism (ERM) experience?

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