Line chart of One year ahead forward interest rate in overnight index swap market (%)  showing Financial markets have expected negative interest rates since May

BoE ‘mixed messages’ keep everyone guessing on negative rates

Andrew Bailey issued a clarification of the Bank of England’s stance on negative interest rates on Tuesday, saying the central bank had not yet reached a judgment whether or when to set rates below zero for the first time.

The governor’s online speech to the University of Belfast was the latest in a series comments from BoE policymakers over the past two weeks, which have served to confuse, rather than clarify, the bank’s intentions on negative rates.

The ambiguity has prompted comment from banks in recent days, with RBC Capital Markets complaining about “mixed messages”, and Nomura noting how the BoE “seemingly poured cold water” on the chances of negative rates, then “revived the possibility of them being used” before “once again dampen(ing) market expectations”.

The question of negative rates is of crucial importance to the BoE because it would determine whether the central bank can still use interest rates as a tool to stimulate the economy.

There have been renewed concerns about the central bank’s communications around the issue after Silvana Tenreyro, an external member of the Monetary Policy Committee, talked over the weekend of “encouraging” evidence from Europe on the effectiveness of negative rates, only to be contradicted by deputy governor Dave Ramsden on Monday, who said there was evidence that the effective lower bound for rates — where monetary policy provides most stimulus — was the current level of 0.1 per cent.

Jagjit Chadha, director of the National Institute of Economic and Social Research, a think-tank, noted that much of the confusion arose from the central bank not having a set policy, so instead of considered analysis, “we see bits of ideas appearing in speeches and (policymaker) comments”.

He added it was very difficult to find the programme of research that underpinned the central bank’s thinking on negative rates. Unelected experts needed to decide how best to think about the policy before talking in public, he said. “You wouldn’t find a surgeon musing in public, ‘Now, how shall I cut into the thorax today’.”

However, the BoE is relaxed about the messages and clarifications it has issued in recent weeks. The differences are not as dramatic as when Mr Bailey commented in the second week of May that the BoE was not “planning for or contemplating” negative rates only to say a week later that the policy was under “active review”.

That U-turn was highly market-moving, generating expectations — which have been maintained — that the BoE would set negative rates. Subsequent market movements have been more modest.

The September MPC minutes and subsequent clarifications, which revealed that the committee had been briefed on how to implement a negative rates policy and that the BoE had begun “structured engagements” with banks on the operational details, were widely reported but resulted in quite modest market movements in expected interest rates.

The BoE thinks that markets often overreact to statements and little harm was done by the central bank publishing a factual account in the minutes of its operational discussion over negative rates and then issuing a clarification a few days later.

One reason for the multiple comments on rates over the past two weeks is that Mr Bailey is more relaxed than his predecessor, Mark Carney, over open debate in the MPC.

At times of economic difficulty, Mr Carney put considerable weight on unanimous messaging which he would front, sometimes irritating other committee members and earning him the nickname, “the unreliable boyfriend”, when he broke reasonably firm commitments on interest rates.

By contrast, Mr Bailey’s view, expressed in his pre-appointment hearings, is that all MPC members are equal and should get a chance to share their views. “No member has a larger or smaller influence than any other (on BoE policy committees),” he wrote in March.

The governor has been at pains to say that the BoE has not yet decided whether to use negative rates. They are “in the tool box” but the central bank is not yet in a position to use them to stimulate the economy and no MPC member has expressed a view in favour of using them any time soon.

In any case, before deploying negative rates, the BoE first needs to work out whether there are operational obstacles, a process which would take place before the end of this year. The MPC would then vote on whether or not to use them.

Some close observers believe the BoE revels in the current ambiguity because it loosens monetary conditions in financial markets — as shown by negative rates in forward interest rate markets — without policymakers needing to take the risk of actually imposing them.

Krishna Guha, vice-chairman at Evercore ISI investment bank, said: “The Bank wants a credible option of going negative in 2021 and to enjoy in the interim the easier monetary conditions this option creates today, but is not set on going negative”.

That is a strategy that will last at least until the end of this year. Next year, the BoE will have to come clean and choose whether interest rates are to go negative in the UK for the first time in the central bank’s 326-year history.