There was recently a lot of talk in the corridors of power and among the markets of negative interest rates, and if the UK and US would soon implement them. Bank of England governor Andrew Bailey has an ambiguous stance on negative rates and President Trump is a confirmed fan of them, but what are negative interest rates and what would they have meant for savings?
Why be so negative?
Central banks have many roles, and one of them is to act as a banking service for a nation’s commercial banks. High-street lenders keep excess funds with central banks as a reserve, and central banks traditionally pay interest on those deposits. This interest rate is known in the UK as the Bank Rate, or if one is in the Eurozone, the Deposit Rate, and has a marked effect on the entire economy by raising or lowering the cost of bank lending. A lower bank rate will tend to stimulate more lending, whereas higher rates will reduce it.
Negative rates effectively reverse this interest model, meaning that the commercial banks now must pay to deposit funds with the central bank. The commercial banks naturally want their funds to work as hard as possible, so lending becomes more profitable than saving. As all the banks are looking to lend simultaneously, competition in the market does its work and ensures that the interest rates to the borrower are favourable, and the economy is subsequently stimulated by giving investment a boost.
Seems radical…
It’s not as radical as you might think and is just the ultimate extension of continually lowering rates. Several Central Banks currently have negative interest rates, among them the European Central Bank (-0.5%), Denmark, (-0.52%), Switzerland (-0.65%), and Japan (-0.04%). Many of these interbank rates have been below zero for quite some time, so it is certainly not a new phenomenon.
The Bank of England‘s bank rate was sailing close to negative at 0.1% during the COVID-19 crisis and prior to the announcement today, but with no change to the bank rate, the Bank of England governor Andrew Bailey has chosen instead to increase economic stimulus via expanding the BoE’s programme of quantitative easing – buying more bonds, with the net effect of lower borrowing costs and increasing money supply without slicing the bank rate past zero.
In the weeks prior to today’s announcement, however, Bailey stated that negative interest rates are under “active review” and that ruling out a cut to negative rates would be “a foolish thing to do.” This after a £3.8bn gilt auction by the Debt Management Office, in which it sold three-year government bonds with a yield of -0.003%. Traders were inferring a move to negative rates prior to the announcement based on movements in the market, and as there are still many risks facing the UK economy, and the BoE may yet come under renewed pressure to take further action, the UK could still see negative interest rates sometime in the near future.
So, it’s all positive?
Well, since negative rates have not been introduced and stimulus has been provided by other means, it seems like business-as-usual for potential borrowers, but the picture for savers is continuing to be gloomy. With recent and now continuing low rates, savers have seen cuts to savings products as a result. It would seem then, that shopping around for a better deal is more important than ever, but with so many products on offer, how do you ensure that you pick the best rates and stay on top of constant rate-changes? This is where a savings platform might help, as a single ‘sign-up’ gives access to a portfolio containing a large number of centrally managed savings accounts, distributing savings across the portfolio, minimising risk of a single point of failure, and maximising protection under schemes like those of the FSCS.