What are negative interest rates?

When we talk about interest rates, to most the first thing that comes to mind is what we pay for our mortgages.  But the term "interest rates" is often used interchangeably with the Bank of England base rate.

The Bank of England Base Rate is described as the "single most important interest rate"  in the UK". It’s the rate which determines how much interest the Bank of England pays to financial institutions that hold money with it, and what it charges them to borrow.

Your bank will then use it to determine how much interest they pay to you, as well as what they will charge you for your loan or mortgage.

Using the base rate, the Bank of England can control how we spend or save, it usually lowers the rate when it wants you to spend more and save less, and it raises the rate when it wants you to save and not spend.

In March 2020 the Bank of England lowered the base rate to a historic low of 0.1% to try to stimulate the economy amid the coronavirus pandemic. Now as the UK hits record borrowing of ￡62 billion in April, another rate cut is on the cards –which for the first time in the Bank’s 325 year history will see interest rates dip into negative numbers.

That’s good, right? Taking interest rates below zero follows the idea that lower rates stimulates the economy. But in reality, it’s not that simple.

Why would you keep money in the bank when they are going to charge you and give you back less than you put in? You wouldn’t.  You would simply keep it at home for free.

So why now?

The Bank of England closely monitors the UK’s inflation rate, and we measure this by the Consumer Price Index (CPI) which in April 2020 fell to 0.8%, down from 1.5% in March. Unfortunately, this now means inflation is below the Bank’s target of 2.0%.

This is great news if you want to buy goods and services, but the longer inflation remains low the more this is then factored into salaries and pay rises - at which point with static pay, spending takes a nose-dive.

So with this in mind, the central banks around the world have been cutting rates in a delicate balance of making money cheaper to boost consumer confidence and make borrowing cheaper, while still having a reasonable rate of inflation to allow the economy to grow.

With rates approaching zero, several central banks took the next step: they went to negative rates. Sweden, Switzerland, Japan and the 19 nations of the Eurozone all took interest rates below zero.

How will this affect you?

In the UK, savers have seen returns fall over the past few years, with many banks only offering rates as low as 0.45% on instant access accounts, and Cash ISAs requiring you to lock away your money scarcely returning rates of 1%.

With fierce competition between the high street banks over consumer accounts, nobody wants to lose business especially as it’s been made easy to switch to a new bank. Businesses will be hesitant to move as most spend years building a relationship with their branch. Banks have to balance their books and with consumer confidence already low in the banking sector, the institutions will be quick to look at commercial and business customers.

In countries with sub-zero interest rates, commercial banks have passed them on to big companies.

So will my bank pay me for my mortgage?

Banks are very slow to pass on the benefits of lower interest rates to borrowers. In 2009 UK interest rates were slashed to 0.5%, prompting some borrowers to think they could be in line for a payment.

Around 1,500 Cheltenham and Gloucester customers had a mortgage that tracked 1.01 percentage points below the Bank of England base rate. An FCA spokesman said, "If the specified interest rate drops beneath zero, we believe that the borrower's obligation to pay drops to zero, but not below".

Any prospect of a windfall was quickly dashed when financial regulators described interest payments as "a one-way obligation on the borrower".

Banks profits will be squeezed by negative interest rates as the margin they make on loans will be squeezed against what they make on paying pay savers, more so with building societies as they hold ￡1 in every ￡5 of savings. The funds they loan out are raised from consumers savings and with investors looking for better returns this could hit them hard.

Investors will be looking to boost their savings and will look to other saving or investment options. Many will look to debt-based investments which offer a fixed rate of return.

In 2008/2009 HM Treasury understood the need for alternatives kick start the economy and in their Financing Public Sector Recover report stated that “These products will be important during the recovery as firms look to use asset finance for financing investment...”.

Listed debt-securities, such as the Propiteer Capital Bonds, made an impact over a decade ago and now form part of the essential tools that businesses will turn to.