The impact of negative interest rates

Recent speculation has raised concern about the Bank of England considering negative interest rates as a way of stimulating the UK economy.

Since the financial crisis, negative interest rates have featured in global markets, but the UK rate has (narrowly) remained positive.


The Bank of England base rate is currently 0.1%, the lowest it’s ever been in UK history.

The ‘bank’ or ‘base’ rate is the level of interest the Bank of England pays to commercial banks on their deposits. Typically, other banks set their loan rates according to the Bank of England base rate.

Negative rates mean that commercial banks would have to pay the Bank of England to leave their money there, rather than earning interest on it. Setting negative interest rates would incentivise banks to take their money out of the central bank and encourage the lending of it to customers and to businesses.

Borrowers

The low base rate is good news for individuals repaying an existing mortgage and those wishing to take out a loan.

For example, a loan’s interest rate is often base rate plus their chosen %, so if the base rate falls, then so does the interest rate on these loans.

It also encourages individuals to spend or invest rather than save, increasing the demand for shares, which increases the price.

Having access to cheaper loans encourages businesses to borrow and invest the money into their growth, supporting the UK economy overall and the stimulating the stock market.

Savers

It’s bad news for savers, with the interest paid on savings remaining very low (typically less than 1% at present) and perhaps becoming lower.

Banks may choose to pass their costs onto customers by charging for previously free savings or current accounts – although they will need to be careful, as they need customers’ money to stay in their accounts if they are going to have enough money to lend to borrowers.

Investors

Negative interest rates provide both risks and opportunities.

The value of the pound is impacted when UK interest rates are low, causing international investors to receive less interest on their UK share holdings. Equally, UK investors could see a better return on their international investments.

Setting negative interest rates and decreasing the value of the pound would also cause any purchases made in other currencies to be more expensive, increasing costs for businesses importing goods and services from overseas. On the other hand, exporters could see profits rise as a result of the weak pound.

It is our belief that only capital which needs to be immediately accessible, as a ‘liquid reserve’ or ‘rainy day’ cash fund, should be retained on deposit in a bank or building society deposit account.  In our view, other ‘asset-backed’ investments are much better suited to providing the prospect of significant investment returns in the medium to long term.

We may learn more about negative interest rates from the Chancellor of the Exchequer at the next budget on 3rd March.


Remember that the value of investments and any income received from them can fall as well as rise and you may not get back what you invested. Most investments should be considered as a medium to long term commitment, meaning you should be prepared to hold them for at least 5 years. Past performance is not a guide to future returns. This article isn’t personal advice.


We can help

Whatever the outcome, if you wish to review whether your cash is working hard enough for you, please contact us by email: info@innesreid.co.uk or on our normal number: 01244 347 583 during office hours.

The first consultation with one of our Independent Financial Advisers is free and appointments can be made outside of working hours, face to face or over video conferencing.

 

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