Negative interest rates and what it means for savers

The idea behind dropping interest rates below zero is that lenders will pay you to borrow and you will be charged to save. Anna Bowes of Savings Champion looks at how negative interest rates might come about.

 low interest rates

The Coronavirus pandemic has put huge pressure on economic growth, inflation and interest rates. Interest rates are already at record low levels but could they go further? As we head well into the second half of 2020, more questions are being asked about the possibility of the Bank of England (BoE) implementing negative interest rates. But what will this mean for our savings?

Why might we experience negative interest rates?

In response to the pandemic the Government adopted a quantitative easing (QE) programme, the expansionary monetary policy that allows central banks to pump new money into the economy to encourage UK companies to quickly rebuild their supply levels.

The demand side shock is more difficult to fix in the short term due to the ever-growing uncertainty which is looming over our heads – meaning more of us may be cautious about spending our money right now. Quantitative easing does not automatically create inflation, as the government is issuing the new money supply in return for less liquid assets.

Inflation fell to a five-year low of 0.2% in August 2020, significantly lower than the BoEs 2% target. Yael Selfin, chief economist at KPMG, expects that while a bounce back is likely in September to reflect the end of the Eat Out to Help Out scheme, “overall inflation is likely to remain well below the Bank of England’s target for some time”.

As inflation is a key consideration when the Monetary Policy Committee (MPC) sets the interest rate, it could mean, in theory, that interest rates could fall below 0% in the coming months.

And in fact, the Bank of England has signalled on more than one occasion that it make take the cost of borrowing to below zero.

The Prudential Regulation Authority (PRA) – at the Bank of England – has recently written to financial services bosses to find out whether they are ready for zero or negative interest rates. However,  Sam Woods, PRA deputy governor and chief executive officer insisted that: “This structured engagement is not indicative that the Monetary Policy Committee will employ a zero or negative policy rate”

If this were to happen though, it will be the first time in the BoE’s 325-year history but it’s not completely unfamiliar territory as some of our European neighbours have experience of this, so perhaps we can take some learnings at least.

The idea behind dropping interest rates below zero is that lenders will pay you to borrow and you will be charged to save.

The reality of course may be somewhat different. But ultimately, it is an act of trying to get us to spend and borrow more to stimulate the demand that the economy is currently lacking.

However, banks may be reluctant to transfer on the cost of negative interest rates to their customers because it may encourage them to remove their savings from their accounts. This would mean banks would have reduced profits from the extra cost they are taking on.

If they did transfer the extra cost of negative interest rates to the customer, it would be likely that they will scare people away from ‘saving’.

Both of these scenarios have direct pressure on banks profit levels. The less profits they generate, the less cash they have in reserve and therefore the less they have to lend. This is exactly the opposite of what the policy would be intended to do.

What will negative interest rates mean for cash savers?

Negative interest rates could mean that the banks and building societies would have to pay to keep money on deposit with the Bank of England, however it’s unlikely that they would charge all customers on their savings.

That said, the high street banks are already paying as little as 0.01% on easy access accounts – so there is little wiggle room to cut rates further. Could they start to charge customers on their savings – in the way that some current accounts charge a fee?

If they did this, it could be the catalyst to get loyal savers to move their money from their bank. However, the worry is that if they do withdraw their funds, they keep it stashed under the metaphorical mattress, which would create a big security risk.

Hopefully it won’t come to that though, as there are likely to still be plenty of savings providers who will be keen to continue to raise money from savings customers.

So, we’d expect to see accounts still available which pay at least some interest – but it’s more likely that these will be providers that are relatively unknown.

The key thing for savers to do is regularly review and move their cash if they can find better rates. And perhaps putting some cash into a fixed rate bond could protect that cash from any further interest rate cuts – at least until the end of the term.

Savings Champion independent, whole of market Best Buy Tables are here

Anna Bowes, is co-founder of Savings Champion.

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