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The Prospect of Negative Interest Rates - Ask the Experts

Published: December 9, 2015
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Author: Carl Shave - CEO and co-founder
Last updated: December 9th, 2015

The prospect of interest rate rises has been one which has been floated for sometime. What makes this a particular interest of the consumer is the effect it would have on personal finances, loans, investments and of course, mortgages. What has received less scrutiny in the media is whether or not the Bank or England might be forced to impose negative interest rates. A far cry from the optimism that means a rise in interest rates may be required, negative interest rates themselves would present uncertainty and for many may form a bleak outlook. We’ve asked some leading financial experts to weigh in on negative interest rates, what they’d mean for the UK economy and the man on the street.

Simon Lambert – Editor, This is Money

simon lambert

I think it is extremely unlikely we would see negative rates in the UK. There would need to be another severe bought of financial crisis before this became something the MPC would be likely to vote through. For a while the money markets were forecasting that this would occur but the Bank of England indicated the next likely move for rates was up. I don’t necessarily think that the Bank intends to rush in and follow the Fed in raising rates, but the US move upwards makes a UK move down less likely. One thing the bank will be keeping a close eye on, however, is the pound. Divergence between the UK and eurozone could see the pound climb against the euro and spell trouble for industry and exporters.

Henry Pryor – henrypryor.com

henry pryor

Negative interest rates would not be a new global experience as others have said but the economy and the housing market in particular would take a while to adjust. Negative rates would be seen by many as a signal to invest in assets rather than in savings so the prices of everything from homes to race horses could rise in the short term. However, in the longer term there would be concerns that the economy was out of control. The Mortgage market would become schizophrenic leaving many buyers unable to decide whether to borrow at all. Uncertainty is not the friend of any market despite the opportunities it creates. Borrowing to buy a house would still have a cost it’s just that lenders would have the added incentive to get money out rather than to sit on it as some have done during the period of QE (Quantitative Easing).

Frances Coppola – coppolacomment.com

frances coppola

Negative interest rates are effectively a tax on holding money. If they take the form of negative interest rates on reserves, they tax the deposits that banks make at the central bank, which is intrinsically a form of monetary tightening. However, they also create an incentive for banks to try to pass on excess reserves to each other, which would typically be through additional lending or securities purchases, or through the interbank market. From a monetary perspective, negative rates are only stimulative if the higher velocity of money generated by banks’ desire to unload taxed reserves fully offsets the tightening effect of taxing reserves. From a macroeconomic perspective, if negative rates result in increased lending and/or support increased corporate debt and equity issuance, then they may have a stimulative effect on the real economy even though they put pressure on banks’ margins. There is however a risk that banks will pass on negative rates to customers. This could be in the form of lower rates to savers, which could at the margin reduce saving and increase spending – though this is problematic, since interest rates on savings are already on the floor and customers are likely to resist outright negative rates. Or it could take the form of higher interest rates on lending. This latter form could prove to be counterproductive, since higher rates discourage borrowing. Since bank reserves never leave the banking system (contrary to popular mythology, banks do not “lend out” reserves), the possibility that banks may pass on the negative rate to borrowers should not be discounted. In January, Credit Suisse did exactly that in response to negative deposit rates at the ECB and SNB. Sweden’s central bank has experimented with negative rates on both excess reserves AND lending to banks. I think this is unlikely in the UK, but if the Bank of England did go down this path then I think we would see increased “churn” on the interbank market rather than an increase in lending to the real economy.

Shaun Richards – Notayesmanseconomics’s

shaun richards

Negative interest rates have been a very real prospect for some time now, we just have to look around Europe to see it at work. From -0.2% to -0.75% in some cases, it clearly demonstrates that Europe’s central banks are willing to move in that direction. Considering Sweden which currently sits at -0.35% because of the generally low global rates and outlook has remained negative for nearly a year now AND MAY EVEN FIND ITSELF CUTTING AGAIN NEXT WEEK. These negative rates in Europe are only going to put pressure on England through the currency markets to follow suit.

What makes the prospective of negative interest rates more likely is if we see commodity PRICES FALL FURTHER or we witness a slowing of the growth forecasts we’ve seen. In this scenario the Bank of England will likely be forced into either investigating negative interest rates more thoroughly or be faced again with Quantitative Easing – which Mark Carney (Governor of the Bank of England) does not seem too enthusiastic about. 

With regards of what this means for the man and woman on the street, in most instances the negative interest rates hit the wholesale markets first, and very often are not ACTUALLY NEGATIVE FOR THE ORDINARY PERSON  FOR A WHILE. The time for this to trickle down into personal banking within Europe seems to be around a year or more and that’s when it may start to bite the consumer – and there’s no reason this may not be the case within England too. To escape the idea of an “under the mattress” economy arising we could even be faced with a scenario where cash is banned – albeit this is drastic course of events, it could be conceivable to keep on top of things.

Daniel Wright – poundsterlingforecast.com

daniel wright

Negative interest rates are another route to take to try and get the economy moving again. Basically it should lead to people taking money out of the banks and finding other options which should incentivise investment and spending as otherwise people will have to pay to hold their money safe in their own bank account so naturally they look for other options. It should also make borrowing costs cheaper which again should be a helpful boost to the economy. A further cut in rates may also be good for exports as it should decrease the value of Sterling due to the Pound being less attractive. The concerns that I would have is that we may see a flight of money out of the country or people holding more cash however it is doubtful that this would be on such a large scale that it would have much of an impact. Negative interest rates in my opinion would lead to quite a bit of Sterling weakness.

Graham Clark – moneystepper.com

Graham Clark

The theory behind negative interest rates it that banks will lend at lower rates, thereby encouraging lenders to borrow more at lower rates, increase their consumer spending and hence revive the economy. The first question over this approach is whether increasing consumer debt is actually a good way to drive the economy forward. This didn’t work out too well in the mid 2000s, did it? Secondly, reducing central rates may not even have this desired impact as it banks will try to maintain their margins. For example, the UK base rate has been 0.5% since 2009 and the 2-year government bond is currently 0.64%. However, the average 2 year fixed mortgage rate is still around 2-3% and the cheapest personal loans are between 3.5% and 4%. Equally, banks will also strive to continue to offer positive interest rates to savers and current account holders due to a fear of losing customers in the short term by reducing their rates. If these consumer banks do reduce rates to below zero, we could see an even bigger problem: welcome to the “under the mattress” economy!

Katie Evans – Social Market Foundation

Katie Evans

In the simplest terms, negative interest rates should improve life for borrowers by making their loans cheaper, but reduce the rates of return that savers can expect to receive on their cash. That’s the theory, at least. But what are the real implications for personal finances? 

Firstly, we would expect saving to fall. The UK already has a problem with low household savings – four in ten adults don’t have £500 of savings to cover an unexpected bill  and 12 million aren’t saving enough for retirement . Negative interest rates are likely to make this problem worse, and could also encourage the sort of unhealthy reliance on consumer debt we saw pre-crisis. That’s not good news for the financial resilience of households.

We’d also expect consumers to seek returns elsewhere if cash savings don’t pay. In the UK, that’s likely to mean an increase in demand for housing, particularly buy-to-let housing, and could push prices up further. I wouldn’t call the current situation, driven by a fundamental supply shortage, a bubble but there is a danger negative interest rates could push us in that direction.

Furthermore, negative interest rates could increase inequality. While the experiences of countries who have tried negative rates suggest it wouldn’t lead to a boom in mortgage lending, the cost of borrowing would remain at rock bottom for those who could afford to do so. Those with substantial incomes and existing assets could borrow cheaply and invest in assets like property. Those on lower incomes, meanwhile, would find it even harder to save for a deposit and see house prices rising further out of reach. The gap between the wealth of those at the top and bottom of the income distribution has grown since the crisis  and we should be very wary of any policy which could stretch this further.

James Faulkner – Master Investor

James Faulkner

Firstly, I should say that the Bank of England has spoken out against negative interest rates on several occasions, so we are unlikely to see negative interest rates in the UK any time soon. However, they are already a reality on the continent, which is still seemingly mired in demand deficiency. Some central bankers believe that negative interest rates are the best way to force consumers and businesses to consume and invest more, as the alternative is effectively to pay the bank to look after their money. However, there are some commentators – and I count myself among them – who would point out that negative interest rates are but another instrument of ‘financial repression’, which has seen savers and investors forced to adopt ever riskier strategies in order to get a return on their capital. We are quite literally in uncharted territory here. The Federal Reserve may have tentatively begun to hike interest rates, but it remains to be seen how the malinvestments and distortions built up over years of zero interest rates and quantitative easing will unwind under more ‘normal’ interest rate conditions. Should the global economy take a turn for the worse and force the Fed to backtrack on its decision, central banks the world over have very little firepower left in their arsenals to combat another recession. Under such a scenario, we could all become a lot more familiar with the concept of negative interest rates.

Carl Shave – Just Mortgage Brokers

Carl Shave

With the Bank of England base rate being at an historic low of 0.5% since March 2009, much emphasis has been on speculating when this will rise and by how much.  However certain analysts have a firm belief that negative interest rates are a genuine prospect to give our economy its well needed boost.  Chief Economist Andy Haldane, has said that Britain may require radical action to bolster the economy. Arguably a less than conventional view but, could it happen? Effectively by bringing in negative interest rates it gives less incentive to save money and encourages people and businesses to spend. In turn this boosts the economy with the result of greater growth. Banks would also be encouraged to lend more as the reserves they hold with the Bank of England would incur interest rather than earn it. How would this effect the average mortgage holder on the street?  Would those on tracker mortgages be paid by their lender?  A nice thought but, it is unlikely with many lenders having a floor on how low a tracker rate can go, and regardless they would perhaps also call on other legalities in the terms and conditions of the mortgages to ensure this did not happen.  It could also be that the Bank of England will actually kept base rate at 0.5% and simply alter the terms of the reserves banks hold, such as charging them for any funds held in excess of the necessary maximum to again encourage them to lend. Savers would perhaps be the worst affected as they see the return on their money disappear and indeed a possibility of having to pay your bank for keeping your money.  This of course is the thought behind the vote of negative interest rates but there is no guarantee this would happen and, it could simply start to breed the very risky strategy of people keeping cash or others seeking investments/savings overseas. It may be an alien idea to most but it is a matter we have to look at seriously when other economies have adopted the process with perceived success.  I still personally believe The Bank of England and banks will continue to look at other means of stimulus before negative interest rates are considered, and that perhaps this so called “radical” idea will remain just that.  

Over to You

What do you think of the prospect of negative interest rates, do you think they’re likely to happen any time soon, are you concerned over what might it bring? Let us know in the comments below!  

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