John-Paul Coleman, head of markets and treasury at Danske Bank, looks at the effect the Covid-19 crisis could have on markets both globally and closer to home
Given the volatility that has engulfed world markets in the past three months it would be a brave analyst who is prepared to give a firm prediction on what might happen to them in the months and years ahead.
The economic statistics released during the coronavirus pandemic don’t make for comfortable reading and while most economists believe the global recovery has already started, it is generally agreed that it could take several years to get back to the growth levels experienced pre- Covid-19.
This month we got data showing that the UK economy had contracted by more than 20% in the early months of lockdown, figures which forced the Bank of England’s governor Andrew Bailey to state that the bank was “ready to take action” as the economy comes out of it. UK Government borrowings rose above 100% of gross domestic product in May for the first time since 1963, reflecting the fall in economic output and the surge in spending it has had to undertake to counter the fallout of the pandemic.
It is no surprise in light of that statement that the discussion has started once again about whether the central bank might soon take the unprecedented step of introducing negative interest rates. The Bank cut its base rate to 0.1% from 0.75% at the start of the crisis, the lowest level in its history, but the depth of the economic hit means it is now being encouraged by some to go further.
Seen as a means of fighting inflation, negative interest rates make it more costly to hold on to money, so, in theory encourage more lending from commercial banks to the private sector and incentivise spending. Whether or not negative interest rates would really stimulate the UK economy is unclear.
Markets have been pricing in the possibility of a reduction below 0 given recent comments from BoE officials implying it is a consideration but I’m not convinced they will go this far while they still have other tools available to them in quantitative easing that would inject new money into the economy through the purchase of government gilts. The Bank of England at its regular monetary policy meeting on June 18 announced the increase in the purchase of government gilts by additional £100bn, which will take the total to £750bn.
So what does all this mean for people and businesses in Northern Ireland?
One very noticeable trend since April has been the weakening of the pound against the euro and our expectation is that it will get weaker still in the short term. The risk of negative rates allied with data indicating the UK economy many come out of coronavirus slower than the Euro economy, not to mention the uncertainty that still surrounds Brexit are likely to weigh the pound low for some time. While this could further dent GDP, one potential benefit could be around exports.
Though I don’t anticipate negative interest rates, it is clear that rates will be very low for the foreseeable future. On the personal banking front, this doesn’t necessarily mean it will be cheaper to borrow, but certainty that fixed rate borrowing will stay at this all-time low level for some time could be received positively.
The downside of that is that, with governments creating money, it is hard to see a big need from banks for savers’ money and that means there isn’t much prospect of improved returns on deposits.
Easier monetary policy generally makes it difficult for savers to generate income and investors have to take more risk to get the same level of return. Even if negative rates don’t happen there still aren’t big incentives for saving more.
In recent months Danske Bank has been lending significant amounts of money and taking additional measures to ensure Northern Ireland businesses keep moving and households stay solvent. It has been great to see factories and shops open and pubs, restaurants and hotels will soon follow.
Both the government and the BoE will be acutely aware of the need to get consumer and investor confidence moving in the right direction – which is likely to mean the BoE continuing to be a big buyer of government debt.
Even with the announcement of the additional £100bn expansion in its quantitative easing and a slower rate of purchase then the market expected now forecast to be complete by the turn of the year, additional purchases are expected by the market in 2021. The BoE has already massively increased its programme of quantitative easing since the start of the coronavirus pandemic and needs to see the economy picking up quickly as there is only so long it can maintain that strategy.
John-Paul Coleman is head of markets and treasury at Danske Bank