Pound Sterling Rallies after Bailey Pushes Back on Negative Interest Rates at Bank of England

Above: File image of Andrew Bailey, image © FCA, changed from original by Pound Sterling Live.

The debate over whether to introduce negative interest rates at the Bank of England has intensified over the past 24 hours, and the British Pound is reacting by going higher.

Bank of England Governor Andrew Bailey indicated cutting interest rates to 0% or below was not likely anytime soon.

Bailey told the Scottish Chambers of Commerce there were "lots of issues" with negative interest rates, the merits of which are being debated by members of the Bank's Monetary Policy Committee (MPC).

Bailey's comments come hours after MPC member Silvana Tenreyro said that while the Bank was not ready to act, negative interest rates could be of benefit to the economy.

Tenreyro's comments were not a significant surprise as she has long erred on the side of being proactive when it comes to monetary policy decisions, meaning the market would be on the lookout for commentary from other members of the Bank's decision making panel.

And it is not just Bailey who added to the debate in the wake of Tenreyro's comments, with MPC member Ben Broadbent also releasing a speech on Tuesday in which he failed to even mention negative interest rates at all in a speech delivered during a Bank of England webinar.

But it would have been strange had the Bank's Deputy Governor of Monetary Policy skirted monetary policy altogether and he said monetary policy settings (interest rates and quantitative easing) would remain accommodative for as long as necessary.

"The Committee has also said that it would need firm evidence of a significant narrowing in spare capacity, and of a sustainable return of inflation to the 2% target, before considering whether to withdraw any of this stimulus," said Broadbent.

The decision to omit explicit mention of negative interest rates - even thought it is the central focus on policy debate at present - and instead talk of the conditions required to raise interest rates, suggests he and other members of the Committee are some way off on lending their vote to negative rates.

Above: GBP/EUR reacts to the Bailey comments by going higher.

The Pound has reacted by going higher: the Pound-to-Euro exchange rate is half a percent up at 1.1185, the Pound-to-Dollar exchange rate is up by a similar margin at 1.3594.

The Pound is up against most major currencies, suggesting the UK currency is becoming increasingly reactive to domestic drivers concerning the economy and Bank of England policy now that a Brexit deal has been agreed.

• Market rates at publication: GBP/EUR: 1.1183 | GBP/USD: 1.3590
• Bank transfer rates: 1.0970 | 1.3310
• Specialist transfer rates: 1.1100 | 1.3496
• More about bank-beating exchange rates, here

"GBP/USD rallied above 1.3600 on diminished likelihood of Bank of England (BoE) policy rate cuts. BoE Governor Andrew Bailey downplayed again the possibility of negative interest rates pointing out “there are a lot of issues with it”. We expect the BoE to keep the Bank rate at 0.10% through 2021 and see the risk GBP/USD trades closer to 1.4000," says Elias Haddad, a strategist at CBA.

Bailey said in his speech that he did not believe UK unemployment would hit its projected 8%, thanks to job-protection schemes put in place by the government.

He added that economic activity during the first quarter would be depressed until Covid-19 vaccines are widespread enough to allow a lifting of some of the lockdown restrictions.

Bailey said it is therefore still too soon to reach any conclusion about the need for future stimulus, which includes cutting rates.

Market expectations for a rate cut at the Bank of England in coming months have grown in the first part of 2021 following the imposition of a new nationwide lockdown aimed at stemming the spread of covid-19.

The lockdown is likely to tip the UK back into recession, meaning the Bank of England could be required to offer further support by way of rate cuts, a development that contributed to a soft start to 2021 for the British Pound. The foreign exchange playbook says that when a central bank approaches an interest rate cut the currency it issues declines in value, but should those expectations start to reverse, then the same currency can go higher.

The most recent round of signalling from the Bank's MPC members suggests a more notable deterioration in economic activity and the covid-19 crisis will be required before the take the drastic decision to cut interest rates into negative.

With vaccines now being rolled out at an accelerating pace and expectations growing for lockdowns to be eased from March onwards, the Bank will be in no rush to introduce agressive easing that could ultimately destabilise the country's financial system.

Sterling is expected by analysts we follow to be better supported in the event that the UK economy recovers strongly in the Spring and the Bank of England steps further away from cutting interest rates.

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