What could negative interest rates mean for your finances?
What could negative interest rates mean for your finances?
The idea of dipping below the black line into negative interest rates has been muttered about for months now as one unprecedented economic circumstance gave way to the next like a line of dystopian dominoes.
As the Bank’s Monetary Policy Committee (MPC) of high ranking and sage financial types revealed that, surprise surprise, this wasn’t going to be the month that the base rate of interest increased, it instead confirmed that it was seriously exploring how it would implement a bank rate that dipped below the 0.0 per cent line if necessary.
Already sitting at a record low 0.1 per cent, the news caused the pound’s value to drop against the euro and US dollar. So if you have decided to brave an overseas holiday, this may already be hitting you in the wallet.
But if the world of negative interest rates, which have already been deployed in countries including Denmark, Japan, Sweden and Switzerland, does come knocking, what are the other effects on our financial affairs?
We asked a panel of experts to shine a light on a very grey area.
“Modern societies have been built around the notion of positive inflation – that demand for products and services is larger than the capacity of the economy to provide them,” explains Dr Nikolaos Antypas, a lecturer in finance at Henley Business School.
“Prices go up to reflect the competition for products by consumers and for resources by producers.
“Companies plan their investments in new projects under the assumption that demand will continue to grow, therefore prices will be increasing, at least modestly.
“These price increases will help them pay off the corporate loans they issued in order to finance such plans.”
Price increases also fuel savings by consumers, the pursuit of better paying jobs and the development of more residential and commercial property, for example.
“This is a simplified version of the inflation mechanics, but the suggested implications are stark: switching from an inflationary to a deflationary regime upends the foundation of modern economics,” Antypas adds. Which doesn’t sound a lot like good news…
But many experts believe consumers will be largely insulated from the effects of negative interest rates.
“For example, despite a prolonged period of both negative rates and negative 10-year bond yields, mortgage rates remain stubbornly above zero,” says Alastair George, chief investment strategist for investment research firm Edison Group.
“For savers, banks have often opted not to charge interest on positive balances, except for the very largest accounts. In future, UK lenders and borrowers may be more concerned about future repayments than the cost of borrowing, as negative interest rate policy would only be used if there is a sharp decline in economic activity or loss of consumer confidence.“
But there may yet be some positives. At least in the short term. For a few of us. Though don’t hold out hope that your lender may start paying you for the privilege of furnishing you with a loan.
“Homeowners who are on a variable or tracker mortgage could potentially see rates reduce slightly if the base rate is cut. However, homeowners should expect a reduction of just 0.1 per cent as lenders do have a floor to their rates,” Miles Robinson, head of mortgages at online mortgage broker Trussle, warns.
“In the 2008 financial crisis, people who had tracker rate mortgages pegged below the base rate found lenders reducing their rates to 0 per cent on occasion, but not into the negative because of the floor, as well as terms and conditions in place.
“Those on fixed-rate mortgages will not see an impact on their payments during their fixed term. However, for those nearing the end of a fixed-rate mortgage term, there are some competitive deals out there so now may be a good time to see if you could be saving money.
“If you’re considering remortgaging ahead of your fixed-term mortgage ending, you need to take into account any Early Repayment Charges (ERC). If these charges are less than the savings you could make, it could be worthwhile switching to a better deal.”
“Lower mortgage rates will rekindle the property market and we should be able to see more properties becoming available again, after a period of shy sellers,” Antypas believes, though he warns the impact of lower interest rates during this particular recession may have not have a uniform impact on house prices.
“Since the higher-income jobs have been affected less by the pandemic, we should expect that the relatively expensive properties will increase in price due to higher demand.
“In contrast, since the lower-income jobs have been affected more and these workers opt for cheaper properties, we should expect properties around £300,000 or below to see smaller increases in demand and therefore more stagnant prices.
Unfortunately, any reprieve we enjoy from lower lending costs could be outmatched by the malaise of deflation.
“If inflation does turn negative, we risk seeing mass firings and company bankruptcies, which will subsequently lead to decreases in consumption and savings, and then more firings and bankruptcies,” says Antypas.
“Negative rates may not lead to inflation straight away, but the longer we remain in such a regime, the more we risk the ‘downward spiral’.”
“As Brits we are used to being able to open a bank account and deposit our money, without paying a penny but there is a cost and someone is always landed with the bill,” says Finn Houlihan, managing director at financial advice firm ATC Tax.
“In the UK, banks typically absorb the cost of holding our money and make up the margin on other areas of their operations such as lending. In much of the world it is common practice for banks to charge a monthly fee for current accounts [and] a number of banks appear to be getting ahead of the introduction of negative rates in the UK. “
UBS recently announced a cash holding fee on balances over £500,000, for example.
“Whether consumers are set to see the introduction of fees for basic banking as a result of negative rates largely depends on the mood music coming out of the BoE – if this is a two or three-year short measure necessary to save the economy, the likelihood is that the banks will absorb the cost,” Houlihan adds.
“However, if we are set for a decade of negativity, we can expect to see bank account charges coming into effect before the turn of the year.
“This is one troubling reality for British consumers – fees are easy to instigate for banks. They already hold our cash, so can switch on monthly charges with minimal delay.”
Brits aren’t going to pay a bank to hold onto their money any time soon, so those with cash savings will probably shift it into fixed-term savings products and other assets including gold.
“For others, the introduction of negative rates pulls us into conflict with the decline of cash. Those with limited savings will likely withdraw their money from the bank, reverting to the cash-under-mattress approach, to avoid what they will likely see as unreasonable charges,” suggests Houlihan.
“There is the danger that this move prompts people not to save in any form and encourages additional spending which, when coupled with the availability of cheap borrowing, could create a dangerous financial cocktail for the UK consumer.”
Again though, there’s some disagreement about what happens next.
“We do not feel that consumers will go out on a huge spending spree, instead they are likely to look for areas yielding a good safe and steady return,” Thomas Goldie, a financial adviser at Hoxton Capital Management, says because so many people were caught off guard when the pandemic first hit.
“We would expect that stocks that have remained resilient during the pandemic and continued to pay good dividends will be favoured by financial advisers and retail investors alike. Individuals will concentrate on the income in the form of dividends rather than the return.”
“Government would be the biggest beneficiary [of the BoE interest rate going negative] since it generally runs a big deficit (ie has to borrow) and no more so than today. Households would likely be bigger losers,” says Peter Dixon, senior economist at Commerzbank.
“Although the difference between household interest receipts and payments has moved into balance, having traditionally run a deficit prior to 2008, the pain will fall on future pension incomes. In the low rate environment the amount which pensions pay out – the annuity rate – has collapsed.
“A representative pension currently pays around 4.9 per cent for every pound in the pension pot, compared with almost 8 per cent in 2007. This will only get worse in a negative rate environment.”
Will negative rates work?
The short answer is that nobody seems sure.
“The main problem with negative rates is that there is scant evidence that they actually work in the way intended, by boosting confidence and increasing economic activity,” says Tom Stevenson, investment director at Fidelity International.
“One reason is that there appears to be a so-called ‘reversal’ rate of interest below which people are not encouraged to borrow and spend more but are instead spooked into precautionary savings.
“Some economists argue that very low or negative interest rates lead to low inflation, because they encourage the self-fulfilling expectation that prices will fall.”
OK then, how long might negative interest rates last? There doesn’t seem to be a way of building a consensus on that either.
“Historically, negative interest rates have been a recent sight in the west, while Japan has had its fair experience with zero interest rates and deflation in the last 30 years,” says Antypas.
“The BoE’s goal is to retain inexpensive capital so that economic activity can pick up fast when all the macroeconomic factors are in place. We should see the BoE turn around on its negative rate decision when inflation picks up to the long-term target of 2 per cent.
“We only hope Dr Bailey [the governor of the BoE] pulls the plug of low rates soon enough before we enter a hyper-inflationary environment, which is dreadful in its own right.”