Is the UK moving closer to NIRP?
- October 16, 2020
Co-Head of Europe
Real Estate | London
SummaryNegative interest rates inch closer to reality in the UK as the Bank of England checks on banks’ readiness. The following summarises why the topic is being raised again and a reminder of previous Chatham insights on the subject matter.
The discussion around whether UK interest rates might move negative in the aftermath of the COVID-19 policy response has ebbed and flowed all summer.
From Andrew Bailey’s comment of “ruling nothing out,” in response to the question about a negative interest rate policy, the market seemed to have concluded that it was, in fact, unlikely to happen and that the effective lower bound1 (ELB) for UK rates would remain at 0.1%.
Since then, Monetary Policy Committee member Silvana Tenreyo made a comment in an interview that the Bank of England had been viewing how “successful” negative rates had been in other countries and hence they were evaluating further.
While many countries have moved into negative interest rate territory (Japan, Switzerland, Denmark, Sweden), we look to our closest neighbour — the Eurozone — to assess success. The European Central Bank (ECB) took its rates negative back in 2014 and reported that this successfully lifted the supply of credit. Over time, the ECB noted that negative rates were having a material impact on banks’ margins, leading them to curtail lending instead of lending more. The ECB has since refined the policy and now tiers the application of the negative rate; only applying it to a portion of banks’ deposits (the tiering is based on a multiple of the minimum amount of reserves banks are required to hold with the ECB).
Last week, all UK lenders were contacted with a questionnaire to check how prepared they were for a central bank move to cut interest rates below 0%. The focus of the questions is not about how this might impact lending or the bank’s profitability, but only on the plumbing of their IT infrastructure and whether it could cope. The banks have until 12 November to respond to the request.
From the interest rate market’s perspective, using the forward curve as the indicator, we already see UK rates (out five quarters) dipping into negative territory.
Over the past few months, Chatham has produced some insights to explain NIRP (negative interest rate policy), and ways to manage this as a borrower. In particular, the risk (or existence) of negative rates has increased lenders’ propensity to incorporate interest rate floors into their lending documents. These floors are usually set at 0% but have been inching up recently as lenders look to boost their returns by setting this floor at 0.25% or sometimes higher. Borrowers should see this as another “fee” within the loan structure and calculate the cost of it in different interest-rate scenarios to make sure they understand the repercussions.
More critically is how the existence of these floors in a negative-rate scenario interacts with a hedging product. We see borrowers focus on the loan document and not take into account the impact on their hedging.
In summary, the probability of a move to negative interest rates seems to have increased in the past few months. The final decision now seems to ride on whether the banks will respond with confirmation that their IT is ready to incorporate negative rates. Then we need to get our minds around the fact that fundamental finance theory is completely turned on its head.
Need assistance in thinking through NIRP and the impact on your hedging programme?
Contact one of our experts
1 ELB is the level to which rates can usefully fall. Anything lower than the ELB either has no impact or is counterproductive.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0404
Our featured insights
Perspectives on ESG in commercial and multifamily real estate
We are often asked what we are seeing with respect to ESG terms or provisions in financings, derivatives, investment vehicle structures, etc. While a tremendous amount of attention is being allocated to ESG broadly across the global real estate markets, there is a wide variance of approaches,...
Is the inflation story over-inflated, and what does it mean for interest rates?
The global inflation story has captured the headlines as we emerged from COVID-19 lockdowns and economies reopened. There are different measures of inflation, showing different trends over different measurement periods. This piece considers the key market inflation measures and discusses how this...
European real estate and capital markets update Q3 2021
It’s back-to-school month for most children, and back to the office for an increasing number of workers too. What better time to host our semiannual market update webinar for real estate? On 15 September, participants listened to our experts, Adrian Ng and Jamie Macdonald, provide an overview of...
U.S. real estate and capital markets update Q3 2021
As we wind down on summer 2021, many Americans are returning to the office and sending their children back to school. We recently reviewed the effects of COVID-19 on the U.S. economy and takeaways for the real estate market during our semiannual market update webinar. On September 15,...
U.S. real estate market update—February 26, 2021
Markets are pricing in the first 25 basis points of Fed rate hikes to occur mid-2023 versus early-2024. Benchmark Treasury yields hit their highest points since the start of the COVID-19 pandemic and the levels strained liquidity in U.S. interest rate markets.
Rising yields and a steepening curve — U.S.
Longer-duration yields have risen and the yield curve has steepened in a hurry. 10-year yield touched 1.55% on February 25. The last time it crossed 1.50% was a year ago before the COVID-19 pandemic. The 10-year yield fell below 0.60% on March 9, stayed around 0.60-0.70% for months till...
Could a resurgence of inflation be around the corner?
After years of stubbornly low inflation, markets and economists expect prices to remain stable for the foreseeable future. But there are warning signals from various parts of the global economy that suggest a resurgence of inflation is more likely than many anticipate.
What does 2021 hold for European interest rates and foreign exchange?
2021 sees the removal or reduction of major uncertainties for the market. The agreement of the Brexit trade deal and the roll-out of COVID-19 vaccines are both providing a welcome boost. Some risks remain, and new ones will emerge. What are the areas to look out for in interest rates and FX markets?