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City fires warning shot over negative rates

Lucy Burton
City of London

Pension funds will be wrecked and the financial system squeezed if interest rates are cut below zero, City leaders have warned.

There is growing alarm that the Bank of England could plunge the base rate into unprecedented negative territory from its current level of 0.1pc, after Governor Andrew Bailey told MPs he had reversed his previous opposition to the idea.

Former pensions ministers, bank analysts and fund managers warned the move would be catastrophic for savers and hammers banks' profits, chipping  away at the foundations of the financial system.

Ros Altmann, the former pensions minister, said sub-zero rates would spell disaster for final salary pension funds by crushing their earnings on bonds. This would pile further pressure on firms struggling to pay retired staff what they are owed.

She added: "Trying to fund pension liabilities with guarantees could become ruinous. 

"Negative rates are an unwelcome distortion of capital markets. The policy is designed to boost growth, but its side effects could have damaging consequences that play out badly."  

The policy would mean that banks are charged for hoarding cash rather than lending it out. It would all but guarantee years more ultra-low returns for savers, although a charge on retail customer deposits is seen as highly unlikely.

Investec analyst Ian Gordon said such a move would also be devastating for British banks as it would lead to further declines in revenues. 

He said: "The stimulus the country urgently needs is not experimental and dangerous monetary policy, but rather an early end to lockdown before more businesses, jobs and lives are destroyed." 

Andrew Wilson, who runs Goldman Sachs Asset Management's fixed income arm, agreed that cutting rates below zero in the current climate would heap pain on banks without encouraging them to lend more. 

Rates are already at historic lows and a further cut would do little to boost credit, he said.

Mr Wilson does not believe that firms are put off from borrowing because of the cost of paying back the interest – meaning if he is right, a rate cut would make little difference.

He said: "With interest rates already effectively at zero, we don't think it's the cost of capital that is restraining any liquidity, it's really the availability of it and making sure that it's getting to the parts of the economy that need it." 

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Sending rates below zero would also hit banks in the profit by hurting their net interest margins – the difference between their cost of borrowing and the rate at which they can lend money.

Mr Bailey said Threadneedle Street must consider how the policy could affect the structure and stability of the financial system, as well as the degree to which banks and building societies could pass the change on to borrowers and savers. 

On Thursday the yield on five-year government bonds plunged to a record low as investors braced for the potential of negative interest rates.  

Not all believe negative rates would have disastrous consequences for the finance industry, however.

Goodbody analyst John Cronin said that although negative rates would bring added pressure to lenders,  it could also accelerate economic recovery by encouraging businesses to spend their cash – ultimately benefitting banks in the long run.

Former pension minister Steve Webb, now a partner at pension consultants LCP, said that while ultra-low interest rates puts extra pressure on corporate pension funds, the hope is that low or negative rates will stimulate the economy, improve long-term business prospects and the chance of pensions being paid in full.