A move away from negative interest rates

Tony Ward is chief executive of Clayton Euro Risk

I was interested to see in the press this week comments by Hyan-Song Shin, head of research at the Bank for International Settlements (BIS), suggesting that central banks would have more success in stimulating growth by making lenders increase capital buffers than by cutting interest rates into negative territory.

He argued that negative rates could backfire by deterring lending while more capital encouraged credit creation. A well-functioning financial system, he contended, was fundamental to the success of monetary policy and central banks should view levels of capital as a key to interest rate policy, not just financial stability. “If the objective of monetary policy is to unlock bank lending to the real economy, ensuring that banks have enough capital to support their lending activity is vital,” he said.

We have certainly seen several central banks resorting to negative rates in a bid to stimulate growth, including those in Switzerland, Sweden, Denmark, Japan and the European Central Bank. Mark Carney, governor of the Bank of England, has suggested that this is unlikely to be a policy to which the UK would subscribe. In my view this is correct. This action would serve to make investors nervous about bank earnings and this anxiety would send share prices lower.

It seems to me this harks back to the core issue of confidence – or lack of it. Investors crave certainty, however there now seems to be a genuine fear in the markets that central banks are running out of ammunition as negative interest rates and quantitative easing become ineffective. Questions are also being asked about the strength of several European banks, particularly in Portugal and Italy, and how they may be contributing to our weak recovery.

Whether Hyan-Song Shin’s argument to increase capital buffers is right – and I’m not entirely convinced – he is certainly correct to address the notion that our arsenal of weapons against economic weakness is no longer effective.

Back in February I wrote that the Organisation for Economic Co-operation and Development was calling for urgent action by world leaders to tackle slowing growth. It suggested that ‘monetary policy cannot work alone’ and that ‘a stronger collective policy response was needed to strengthen demand’. I agree wholeheartedly with this approach: fiscal and monetary policy should work hand-in-hand and these policies should be instigated by politicians as well as finance ministers and central bankers.

Innovation remains central to recovery. With central banks running out of traditional monetary policy tools, new ideas are needed. Now.

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