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4 February 2021 By Swaha Pattanaik

If a gun makes an appearance in an Anton Chekhov play, it’s eventually bound to be fired to deadly effect. Bank of England boss Andrew Bailey will be hoping the same won’t be true for the new weapon he is fashioning for his monetary policy armoury.

The UK central bank on Thursday told lenders to be ready to cope with sub-zero interest rates at any point from six months’ time. Peers in other countries have taken the plunge in the past without issuing such formal advance notice. But the BoE’s banking supervisory arm, the Prudential Regulation Authority, reckons that’s how long it will take for all British lenders to make necessary changes to systems and processes.

Bailey took pains to stress this was not a signal that negative rates were on the horizon, only diligent planning to ensure the option was a feasible one if ever needed. Financial markets, which had anticipated a more immediate firing of the negative rates gun, got the message: the pound shot up more than a cent to nearly $1.37.

Bailey said in January that sub-zero rates would complicate banks’ efforts to earn a rate of return, potentially hurting their lending to companies. He may still have to pull the trigger at some point, though.

First and foremost, current pandemic restrictions are tighter than the BoE had expected as recently as November, so economic activity will be weaker than previously anticipated in the first three months of 2021. Of course, that may not be a problem if things pan out as the central bank expects.

Its updated projections’ central scenario envisages restrictions on activity easing in the coming quarters, and foresees a rebound in household spending. Also, the main features of the new trading arrangements between Britain and the European Union are very similar to those underlying the BoE’s November projections. That means the hit to the economy should be of the scale anticipated by the central bank: UK trade is projected to be around 10.5% lower in the long run under the new agreement, and GDP around 3.25% lower, than if trade had remained frictionless.

But things could awry. Vaccine-resistant variants of the virus could mean stop-start lockdowns continue. Or Brexit-related frictions could take a more pronounced toll on the economy. Bailey can hope for the best but is right to prepare for the worse.

 

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