Negative Interest Rates

We appear to be heading for negative interest rates…..how might they work?

With the likelihood of a second lockdown to prevent the spread of Covid 19 increasing by the day, the chances of a double dip recession are growing, and a prolonged period of economic misery and high unemployment is a distinct possibility. The BOE and the government are having to get increasingly creative. Negative interest rates would potentially make it more attractive for savers to spend their savings and make it cheaper for borrowers to take out loans to invest

 

Those outcomes would theoretically pump prime retail sales and investment in the economy and that would be good for job creation. In mid-September, the BOE signalled to the markets that the wheels were now in motion to be able to move to a period of negative interest rates at some stage in the New Year. Many now feel that this is the likely outcome of the BOE’s planning.

What would negative interest rates look like for most of us? Before I respond, I would like to make clear that no-one in the UK really knows what the true answers would be as negative rates have never been tried here before. This would be new ground for all of us! We can however look at the outcomes experienced by others who have taken this step. Businesses in foreign jurisdictions that have introduced negative rates have experienced the benefit of very low borrowing rates but also the pain of having to pay banks to hold their funds. Private customers in the main did receive very low positive interest rates on their savings balances. Some did receive zero interest.

Those readers who are interested in economics or who work in Financial Services will be aware that there has been a great deal of speculation over the last six months as to whether the Bank of England (BOE) is preparing the ground to introduce ‘negative interest rates’. 

At its most extreme, negative interest rates would mean than we would all have to pay to have our savings held at banks and building societies and we would be able to borrow money for free or even be paid for the privilege of borrowing. This would appear to be frankly crackers to most of us, but negative interest rates have been used elsewhere in the World in recent years, most notably in Japan and in Switzerland. Negative interest rates are in fact already with us in the UK although they are not that obvious. As investors have scurried away from falling equity markets over 2020, they have sought refuge in UK Treasury Gilts and have been prepared to pay the government to invest their money on the basis that small negative yields are a price worth paying to obtain the best capital protection that is available compared with investment in other asset classes.

Many banks and building society's would not welcome the introduction of a negative interest rate policy by the BOE as this would inevitably reduce further the interest paid to already hard-pressed savers. They have done the right thing to protect their futures and to give themselves financial security. Paying savers negative rates would just not be natural justice in my opinion. Many lenders, banks and building society's would not be immune from the impact of such a policy if ever it was introduced by the BOE. These establishments have to hold a significant level of our liquidity with the BOE and we would be forced to receive negative yields on these funds. These leaves these financial companies with the dichotamy of reduced profits in order maintain savers interest rates.

I hope that negative interest rates do not come about…. but if they do, it will be interesting to see how banks and buildings societies react to the news.