Negative rates to spur the economy
19th May: Highlights
- Bank of England considering negative rates
- The reality of the lifting of restrictions hits home
- Macron and Merkel propose rescue plan
Spending not saving the current fashion
While this is seen as a radical move, one which BoE Chief Economist Andy Haldane sees as not being the first port of call, the concept itself is as simple as it sounds.
In order to ensure that people are encouraged to spend to keep funds flowing through the economy and to discourage saving, banks would basically charge, rather than pay interest on accounts. The danger of this practice is that if I charge you for holding funds with me, you will simply draw the funds in cash and keep them under the mattress.
The natural conclusion of this is twofold; first there is the obvious security risk and, second, it would undermine the entire banking system by both seeing banks’ loan to deposit ratios destabilized and challenge current payment systems.
Loan to deposit ratios are an important method of controlling risk for Central Banks as financial institutions are only allowed to lend a proportion of the client funds they have deposited with them Thus, a reduction in customer deposits reduces their ability to lend and slows the economy. While this is not yet a matter for the entire MPC it is something that is clearly under consideration.
Both sides in the Brexit negotiations gave fairly negative assessments of the progress so far towards a trade agreement which has also served to undermine the pound. It has fallen by 3.75% versus the dollar so far this month and has also lost ground versus the single currency.
Yesterday, it rallied a little versus a weakening dollar although the trend remains for a test of 1.20 and possibly the 1.10 level against the euro. It reached a high of 1.2227, closing at 1.2197.
Services sector to face decimation
Unfortunately, three issues stand in the way of this ambitious view. First the spread of Covid-19 is far from being under control in the worst affected areas and new pockets of infection continue to arise. The decimation of the services and hospitality industries is a continuing concern with up to 30% of bars and restaurants under threat of failing to reopen, while jobs continue to be lost and just getting back to a neutral position will be a mammoth task.
President Trump and his most senior advisors want to play down the influence of the pandemic over the November election while focussing on the only real success they have had over the past four years, the economy.
However, several FOMC members, including the Chairman, Jerome Powell do not share that enthusiasm.
Larry Kudlow, the President’s Chief Economic Advisor commented recently that Coronavirus will not be allowed to sink the U.S. economy. While that sentiment is probably true in the long run, the when factor is significant. He went on to say that the recovery may take weeks or months, but it won’t take years
Risk appetite is now the major driver of the dollar as it seems that only either the positive effect of an announcement of a usable vaccine or a major spike in infections will drive the dollar in either direction for now.
The dollar index fell to a low of 99.57 yesterday, closing at 99.62, as it was, for once, affected by positive news for the euro.
France and Germany propose grants to hardest hit
The two leaders agreed on the principles of just how they are prepared to fund the bailout. This is a major departure for Germany. It has managed to find a way to get around its constitutional issues and use its significant budget deficit for the good of the Union.
The subject of loans versus grants had been the major sticking point with France, Spain and Italy favouring grants, while Germany, the Netherlands and Belgium preferred loans.
It is unclear just what happened to encourage Mrs Merkel to give ground but it may have allowed the region to stumble forward until the next crisis comes along as it surely. A robust framework will need to be put in place to allow the defence against such crises to automatically dealt with uniformly. That will need the cooperation of the entire EU machine to work in sync which has been sadly lacking so far this year.
Merkel labelled the announcement a short-term solution while the longer term needs of the Union require a discussion
Even a sceptical market reacted positively to the announcement with the euro jumping to a high of 1.0927 versus the dollar, closing at 1.0915. The elusive 1.10 level still looks some way away, but this positive move may have served to place a floor under the currency.
About Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”