BoE realistic about challenge of sub-zero rates for banks, Bailey says

LONDON (Reuters) - Bank of England Governor Andrew Bailey said the central bank was realistic about the challenges negative interest rates would pose for the banking system, but repeated he was not ruling them out as a way to help Britain's economy.

Bailey said the big share of retail deposits - which have tended to continue offering positive rates to investors even in countries which have cut rates below zero - in Britain's banking system could reduce the effectiveness of any BoE negative rates.

"That does not mean to say that we rule out using negative interest rates for a moment," Bailey said in an online speech given to Queen's University Belfast on Tuesday.

"It means to say we are realistic enough, I think, to know that the transmission mechanism would be affected."

Sterling jumped by half a cent against the U.S. dollar on Bailey's comments before falling back.

Investors have been trying to work out the likelihood of the BoE following the lead of the European Central Bank and the Bank of Japan, as well as other central banks, and taking rates below zero for the first time.

The BoE said this month it would look during the fourth quarter at how it might be able to implement negative rates if needed, building on an announcement in August that the option was part of its toolbox.

Deputy Governor Dave Ramsden said on Monday he thought the floor for the central bank's key interest rate remained at its current level of 0.1%.

But another interest rate setter, Silvana Tenreyro, said in a weekend newspaper interview that the BoE's investigation into whether negative rates might help the economy had found "encouraging" evidence.

Bailey reiterated that the BoE had not reached a judgement on whether or when to use sub-zero rates for the first time and that he wanted to push back against speculation that a shift in stance would be coming soon.

He also said Britain's economy had performed a bit more strongly than the BoE thought as recently as last month but there were signs that the recovery will not be as strong going forward.

Economic activity was probably about 7-10% weaker between July and September than before the coronavirus pandemic and had finished the third quarter growing more strongly than in the period as a whole, Bailey said.

(Reporting by David Milliken; Writing by William Schomberg, editing by William James)