The Prospect Of Negative Interest Rates



Last week, there was a lot of focus on the Bank of England’s decision to keep interest rates unchanged.  This was because they warned that interest rates could go negative in six months’ time.

It was reported that the Bank of England has been looking into whether negative rates are even possible to help the economy recovery from the impact of the coronavirus pandemic and has now asked banks and building societies to prepare for their introduction.

Whether such action will be taken largely depends on how the UK economy will naturally recover later in the year, helped along by the vaccination rollout.  The Bank of England’s view is that much of the cash savings we’ve been collectively hoarding (more than £125 billion was added to cash savings accounts last year!) will be “released” in a flurry of spending activity, when we’re allowed!

The economic concern is that a survey by the Bank of England found that 70% of people who used the pandemic as an opportunity to top-up their savings, plan to hang onto the cash at least for now.

 

So, what do we mean by negative interest rates and what could be their impact?

Well, it is fair to say that, as with all elements of economic policy, there will be winners and losers from negative interest rates.

Before we consider the winners and losers, it is worth noting that negative interest rates have been a feature of global markets since the 2008 Financial Crisis.  Until now, the Bank of England has kept interest rates in positive territory, if only by the smallest of margins.  The last interest rate cut to 0.1% was in March 2020.

The interest rate we are referring to is the Bank of England base rate and this is the level of interest that the Bank of England pays to commercial banks on their deposits.  It is important because lots of banks price their loans from the base rate.  A loan’s interest rate is usually said to be “base rate plus x%”, so if the base rate falls so does the interest rate on these loans.  Existing borrowers will then be a winner!

Negative rates also mean rather than receiving interest on their deposits at the Bank of England, commercial banks would have to pay to leave money there.  Having to pay to leave money in a bank seems strange, and certainly makes saving less attractive.  The idea is to encourage banks to take cash out of the central bank and lend it to businesses and consumers, which should stimulate the economy.

For borrowers, access to cheaper debt encourages companies to borrow money and invest in new factories, tools, machinery, etc. sparking growth in the economy.  So new borrowers could be a winner too!

 

What’s true for banks is also true for companies and individuals.  If you’re being paid less interest, there’s less incentive to save and you’re more likely to invest the money or spend it.  You are unlikely to leave savings in a bank account if you have to pay for the privilege!  Existing savers are a potential loser.

When UK interest rates are low (or even negative) that negatively affects the value of the pound.  Because international investors receive less interest on their sterling holdings, the pound’s value will fall relative to other currencies.  That can cause problems for companies that sell imported products in the UK, electrical retailers for example, since the price of stock increases.  It can also drive short-term increases in inflation, making consumer goods more expensive and restricting spending.  Such companies could also be a loser.

 

If you are concerned about the effect of negative interest rates on your finances, and would like financial advice, please get in touch.

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