Weekly Spotlight: What happens if rates go negative?

With some banks considering charging for current accounts and a surge in demand for at-home safe deposit boxes1,2, it seems like many people are already preparing for the Bank of England to slash interest rates to below zero.

The advent of a second lockdown and the expected economic consequences of a second wave of Covid-19 will only ramp up speculation about a further rate cut, as the Bank uses every tool in its box to keep the economy steady. But why do central banks push interest rates into negative territory, and what will happen to your savings and investments if they do?

Some of the answers may surprise you, with economists disagreeing on the possible outcomes of negative rates, which can sometimes come with unintended consequences.

Why negative interest rates?

Central banks push interest rates into negative territory for one main reason - to stop money being hoarded and to stimulate demand. If Britain’s banks have to pay to keep their own money in the bank, the theory goes, they will lend it out instead, keeping the loans and mortgages flowing.

They’ll also pass on the costs to their customers, in theory, who will then spend their money rather keeping it in the bank, causing economic growth. Meanwhile, companies that want to grow can borrow money cheaply from the bank to finance new projects.

The strategy can be used instead of, or in conjunction with, quantitative easing (QE), which is essentially printing money to buy government bonds in order to lower rates and in turn stimulate demand.

Does it work?

We aren’t the first country to be considering negative rates, which means we can look at what has happened elsewhere when rates have been cut below zero. Switzerland and Denmark are two European countries that have pursued negative interest rates in recent years, with their rates going as low as 0.75 per cent in each case, while Japan has also had negative rates for several years.

While the rates should, in theory, encourage people to spend, they do not always do so, because they are usually used at a time of great economic hardship and can ‘spook’ consumers into wanting to save more3.  We’ve already seen that, despite ultra-low rates in recent months, Britain has turned into a nation of savers due to ongoing uncertainty. The UK household savings ratio, which measures how much of our income we tuck away for a rainy day, hit an all-time high of 29.1 per cent in the second quarter of 20204.

So it may be that, if the bank moves to negative rates, the continuing gloomy news keeps us panic saving, rather than just panic buying, even if our money is losing value in the bank and we may be paying to put it there.

What happens to investments?

Negative interest rates have a variety of impact upon different types of investment - some good and some bad.

For those seeking income from a portfolio of stocks and shares and bonds, negative rates are bad news, because bond yields will fall and this will in turn push down yields on dividend-paying shares and annuities.

It could be good news for growth stocks and exporting companies though, with companies that borrow heavily to grow being able to invest more cheaply, and a falling pound making goods from the UK cheaper on international markets.

Financial stocks would suffer, however, because bond prices would rise (although yields would fall), and gold should also go up in value as it is priced in dollars.

Finally, because many savers may feel that they have no choice but to become investors, more liquidity in the system could push up the price of equities in general, which is good news for those who are happy to invest and have money to put away for the long term.

What should I do now?

Interest rates are not negative yet, and there are no guarantees that they will be. However, UK Bank Rate is already at record lows, so many of the effects of negative rates are already in the system to some extent, and will be having an effect on your portfolio and the cash in your bank account.

Depending on your personal circumstances and risk appetite, it may be time to look at whether the money you have in the bank is working as hard as it can for you, or whether there are other ways it could be being used.

Professional financial advice could help you to negotiate this difficult period, ensuring that your portfolio is best equipped to ride out all of the consequences of potentially negative rates.

 

This article is for generic information only and is not suggesting a suitable investment strategy for you. You should seek independent financial advice that takes your individual circumstances into account prior to proceeding with any course of action.