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After four years of low interest rates, are negative rates next? 

 

We have just passed the four year anniversary of the 0.5% UK interest rate. Back on 4th March 2009, few people predicted that the Bank of England would leave its base rate unchanged for four years.  Not only has that happened, but many market commentators predict there will be no increase either this year or next year.  

And to make things worse for savers, the Bank of England has now also mooted the idea of negative interest rates.

The Bank of England’s deputy governor for financial stability, Paul Tucker, raised the possibility in front of the Treasury Select Committee at the end of February.   Persistently sluggish growth is forcing the Bank’s Monetary Policy Committee to consider more radical measures to boost the economy. He told MPs that the Bank could do more to help the economy, and to increase lending to small businesses.

How would negative interest rates work?

Negative interest rates would be charged on banks which deposit funds with the central bank, rather than on retail clients.  However, savers could still see their interest rates reduced even further.

High street lenders keep funds on deposit with the Bank of England.  They currently receive interest, but if negative interest rates were to go ahead, they would instead have to pay the Bank for holding their money.  This is described as a ‘tax’ or ‘penalty’ on banks.

The aim is to encourage banks to lend more to businesses and households, rather than pay to keep it on hold.

The Bank of England has previously considered cutting its base rate from 0.5%, but decided against it as it may bankrupt small building societies.   With this alternative approach, the base rate will remain 0.5%, but a new deposit rate will be created and it is this that will be below zero.   The European Central Bank has two separate rates as standard.

Banks are still stockpiling cash reserves following the 2008-09 banking crisis.  The Bank of England and Financial Services Authority believe they are being too cautious, and this is one reason why the UK economy is struggling to return to growth.

From the government’s point of view, to aid growth it is better for people to spend than to save.

If negative interest rates go ahead and banks start lending more to consumers, borrowers could be better off.

But savers could be the ones who suffer, again.

Savers

Paying to deposit money would reduce profitability for high street banks, so they will look to make up the costs elsewhere.   It is highly likely that they would reduce interest rate on savings accounts, and impose other bank charges.

Malcolm Barr of JP Morgan warns:  “It’s very clear that this would be expected to bring downward pressure on the rates savers can expect, pushing them down towards zero.”

Like any other tax on banks, it is the consumer who ends up paying.

Savers have suffered enough after four years of low rates, and have also been impacted by other stimulus measures like quantitative easing, which includes the electronic creation of money, and the Funding for Lending scheme.   Since the latter provides banks with a cheap source of funding, they have less need to compete for deposits by offering better interest rates.  According to MoneySupermarket, savings interest rates have fallen by a third since the middle of last year.

Will it happen?

The new Bank of England Governor, Mark Carney who will replace Sir Mervyn King in July, is expected to shake up policy.  Senior Bank members have said that a range of ideas are already being considered.

Mr Tucker’s comments to MPs were the strongest indication yet that negative interest rates could be under serious consideration.”I hope that we will think about the constraints of setting negative interest rates, he said, adding: “This would be an extraordinary thing to do and it needs to be thought through carefully.”

Deputy Governor Charlie Bean was quick to dampen speculation, describing the idea as “blue sky thinking” and saying it is just one idea out of many that policymakers have considered and rejected when reviewing more radical options.

He said he wanted to make it “absolutely clear” there is no immediate plan to introduce negative interest rates on commercial bank reserves, but did admit that there was nothing to stop it in principle.

Negative interest rates are not just a theoretical concept.  Sweden, Switzerland and Japan have used them in the past, and Denmark introduced a deposit rate of -0.2% last year.

Although savers will not actually be charged negative rates, when inflation is factored in most are already earning negative real rates of return.  Very few accounts in the UK are paying a rate of interest which beats inflation.

This is an issue for all retirees, wherever you live.  Inflation reduces the spending power of your cash savings steadily year after year, more so when interest rates are low and/or you withdraw the interest.   Over your retirement years inflation can have a significant impact on your spending power and financial security.

Do not bank on interest rates improving in the near future.  Speak to a professional wealth manager like Blevins Franks to discuss tax efficient alternatives for your savings which can generate income and be designed to keep pace with inflation.