Since the leave vote in the EU referendum, the bad economic news has continued to roll in. A survey by the Royal Institution of Chartered Surveyors published on 14 July, which accounts for the post-referendum period, shows a sharp fall in inquiries from homebuyers. Markit’s flash purchasing managers index (PMI) surveys taken after the vote for both manufacturing and services were especially grim. They exclude retail and construction which may well be even harder hit.
The CBI industrial trends survey of 506 manufacturers suggested that the outlook for the next three months is set to soften. Investment is expected to be lower over the coming year compared with the last 12 months. Five percent of firms in the survey said they were more optimistic about the general business situation than three months ago, but 52% said they were less optimistic. Fourteen percent of firms expect employment to increase, and 20% expect it to decline. These data have scared monetary policymakers senseless. The data suggests the UK is slowing and probably headed to recession. The latest GDP data for the second quarter of 2016 show a surge in April and a slowing in May and June.
A week ago two external monetary policy committee (MPC) members both said that the case for a cut in interest rates was unclear. On 20 July Kristin Forbes argued that the MPC should “wait for the Brexit fog to clear before an interest rate cut” and it was “a good time to keep calm and carry on”. Turns out it isn’t. Martin Weale said on the 18 July that the case for a post-Brexit rate cut was “not clear”. A week later he had changed his mind, primarily, he told us, because the PMIs were “a lot worse than I had thought” and they “showed signs of worsening further”. The concern is that this would have negative consequences on banks’ profitability and the supply of credit. A week is a long time in economics. As JM Keynes famously said: “When the facts change, I change my mind. What do you do, sir?” Good for him. Weale joins the Bank of England governor Mark Carney, MPC member Jan Vlieghe who voted for a cut in July, and chief economist Andy Haldane in the stimulus crowd. It now seems the doves are in control. Hopefully, Forbes will have a fast rethink.
To this point the MPC haven’t cut below 0.5%, whereas other central banks went to zero, because of their concerns that this would constrain the ability of banks and building societies to extend new credit. But that is set to change at the 4 August meeting as, for the first time since I voted for a rate cut in March 2009 from 1% to 0.5%, the MPC is going to put those fears aside and is likely to cut rates to 0.25% and maybe even to zero. The MPC has hinted it will put in place a “package” of measures, which will likely include a further round of quantitative easing although we don’t know yet what assets they will buy. But they may not stop at zero and may eventually go lower. I don’t see this happening in August, but there is a distinct possibility down the road, if the data worsens further, as it well might, that rates will have to go negative. Clients are charged a fee for parking their money in a bank. Monetary policy is the only show in town, especially as the new chancellor, who is still getting up to speed, is either unwilling or unable to inject fiscal stimulus, as he should, any time soon. But he may soon have to.
This is not pie-in-the-sky economics; it is a real possibility and banks are already preparing. NatWest wrote to its 850,000 business customers this week, changing the terms and conditions of their accounts and warning of the possibility that negative interest rates may be coming. In the letter NatWest said: “Global interest rates remain at very low levels and in some markets are currently negative. Dependent on future market conditions, this could result in us charging interest on credit balances.”
Everyone else is doing it. Negative rates are already being charged by the European Central Bank; along with the central banks of Japan; Denmark, Switzerland, Sweden and Hungary. Lower rates encourage business investment and consumer spending and the hope is that there is a nice continuum from positive rates to small negatives. The hope is a cut of 25 basis points from 0.5 to 0.25% would have the same impact as one from zero to -0.25%, but who knows? The concern, though, is that negative rates would have harmful consequences on banks’ profitability and the supply of credit. We don’t know if they will work or the exact transmission mechanism they work through. But I would vote for them if the data worsened markedly; they are worth a shot.
How low could rates go? Vlieghe has argued that he thinks rates might go as low as -0.5% or even to -1%. He argues that this is possible because there are costs of storing and transporting and insuring huge piles of cash. But they could it go even lower than that, for a short time, say, to -2% or even lower to give a short, sharp shock, as Miles Kimball from the University of Michigan has advocated. Economists used to think that zero was the lower limit for interest rates, but it seems rates can go below zero. The vote to leave the EU has been a nasty negative shock to the UK economy that is going to lower living standards and cause much pain and suffering. A self-inflicted wound. The Brexiters were warned.