Citi Seeing Negative U.K. Rates Shows Economists Joining Markets

(Bloomberg) -- More economists are catching up to traders in expecting the Bank of England to lower interest rates below zero, reflecting mounting pressure on the economy from the coronavirus pandemic and the risk of a no-deal Brexit.

Christian Schulz, director of European research at Citigroup Inc., said the BOE will likely cut its benchmark rate to -0.1% by the middle of 2021 if the U.K. leaves the European Union without a new trade deal in place. A research note by economists at RBC sees negative rates as early as November.

With borrowing costs already at 0.1% and additional asset purchases by the central bank widely anticipated later this month, the debate is focusing on other measures to help the economy through what could be the worst recession in three centuries. Governor Andrew Bailey and other policy makers have refused to rule negative rates out, but made it clear that it's far from a done deal.

Money markets have been pricing it in for weeks. Investors are now betting the U.K. will join the negative-rates club by the end of February, according to overnight interest-rate swaps. The yields on some U.K. bonds are already below zero.

The risk of “a hard exit from the EU's single market and customs union at the end of the year is too soon and too likely to ignore,” Citi's Schulz said in a note. “Negative rates could prove particularly effective in reducing bankruptcies, protecting rather than undermining monetary financial institutions.”

While more bond-buying and fiscal stimulus would be the first lines of defense in that case, the economy would likely still need more of a boost, Schulz said. Monetary policy could have an important role to play during a big supply-chain disruption because fiscal policy might be less effective.

The central bank said U.K. output could plunge 14% this year in a scenario published last month. A hard Brexit could damp the recovery that officials are expecting.

While building societies have been pointed out as a problem area for negative borrowing costs in the past, that risk seems to have fallen in recent years, Schulz said. Some smaller banks with a large exposure to mortgage lending could still be affected but the immediate risks might be more manageable.

What Bloomberg's Economist Say...
“The reality is the BOE is pushing the limits of its powers to boost spending. If demand did need support, a more potent policy mix would be for the central bank to continue with QE while fiscal policy does the heavy lifting.”
-- Dan Hanson, senior U.K. economist. Read his full REACT.

U.K. officials can draw on six years of experience with negative rates from the European Central Bank, and their review isn't likely to make a strong case against them, RBC said in a research note.

One of the boldest monetary policy experiments of the 21st century, negative rates have been the norm in much of Europe for more than half a decade. But the measure has encountered increasingly vocal opposition in the euro region from both banks and savers who say the policy robs them of returns.

There will likely be resistance within the BOE Monetary Policy Committee, Schulz said. That would, therefore, mean taking take some preparatory steps before taking the benchmark rate even lower.

One example would be limiting the policy to the Term Funding Scheme, a loan program for banks. There's a chance the MPC announces such a move at its next announcement on June 18, he said. It could also make preparations for tiering and re-assess the so-called lower bound, which indicates how low it can allow interest rates to drop.

“The Bank will formally no longer rule out the step below the zero line,” Schulz said.