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Bank Of England Mulls Negative Interest Rate

(c) Sky News 2013

The Bank of England has raised the prospect of introducing negative interest rates to get borrowing going in Britain again.

Paul Tucker, the BoE's deputy governor for financial stability, said it was one of the ideas he had been considering to try to push cash out in the real economy.

Speaking to the Treasury Select Committee (TSC), Mr Tucker said: "I hope we will think about whether there are constraints to setting negative interest rates.

"This is an idea I have raised. This would be an extraordinary thing to do and it needs to be thought through very carefully."

Although several other central banks have experimented with negative interest rates in recent years - most notably Sweden and Denmark - this is the first time the idea has been raised by a BoE official.

At present, the bank pays an interest rate of 0.5% on deposits UK banks leave in reserve at the BoE.

The theory behind negative rates would be to try to encourage those banks to leave less cash at the central bank and instead to lend it out to businesses around the country.

If the interest rate was -0.5%, they would have to pay the BoE a 0.5% rate each year to hold money with it.

However, the idea of reducing the BoE's interest rate to zero - let alone into negative territory as raised by Mr Tucker - has been dismissed by the governor, Sir Mervyn King.

He has cited internal bank studies suggesting it would cause major financial problems for building societies because of the way their balance sheets are structured.

Although Mr Tucker acknowledged that it was "quite a radical idea and not something anyone should clutch onto as the answer to the question of the universe," he agreed to provide the TSC with a detailed written explanation of his idea.

During the committee hearing, Mr Tucker, who until the appointment of Canadian Mark Carney had been the favourite to succeed Sir Mervyn as BoE governor, also acknowledged that not enough cash was getting through to Britain's small and medium-sized enterprises (SMEs).

He said: "I am worried, as are others, that our current battery of credit policies may not be reaching as far as they might. We should have a think about can we harness non-bank lenders.

"The other thing, I find it regrettable that market for working capital finance aren't as healthy as they were. I think that the authorities in the bank could play a role in that.

"Life blood of working capital finance was a trade finance instrument that was transferrable and marketable and that we would buy. We are lending to companies via the FLS I would like to explore whether some kind of working capital instrument."

The chairman of the TSC, Andrew Tyrie, said: "The lack of lending to SMEs is inhibiting economic growth in the UK. The MPC (Monetary Policy Committee) is right to be looking at additional tools, or changes to existing tools, that could help.

"Some of the proposals we heard today, such as moving to negative interest rates, are radical; others are not. They all warrant careful consideration."