What Are Negative Interest Rates?

by | May 28, 2021

The Bank of England has warned high street banks that negative interest rates could be imminent. In today’s current post pandemic economic situation, negative interest rates are another tool used by central banks to boost the economy. They are also used to discourage local banks from hoarding funds and push them to lend more money. To be specific, negative interest rates are an instrument used by central banks to prevent a deflationary trap. This policy should spur the level of investment and borrowing because it will be financially less sustainable for organisations and average consumers to keep their money on deposit in the bank. People and companies should therefore be more willing to invest and/or spend their money.

Unfortunately, negative interest rates may potentially devalue the currency of the country. Although this helps in boosting exports, foreign investors will find it less attractive to do business with the UK as a result. Although the intention is good, negative interest rates as a base rate in the UK may fail in bringing the desired impacts if there are not enough lending opportunities available. This means, the government also needs to implement favourable policies that encourage the rate of investment.

Bank of England negative interest rates will have the following implications to consumers:

    Homeowners- for homeowners with a fixed-rate mortgage, the fluctuation of interest rates won’t affect them. In the UK, the majority mortgages are fixed-rate at the moment. Homeowners with variable-rate mortgages could benefit from a slight reduction in their interest rate. New homeowners could benefit more from this policy because they can negotiate a new fixed-rate mortgage with a lower interest rate.

Savers- people with ample savings accounts will be the worst affected by negative interest rates. Their account will get a negligible return from a lower interest rate and their savings will be effectively eroded by inflation. Analysts forecasted that the UK inflation rate will be around 1.5 percent in 2021. Regular Saver accounts still provide the best yield for cash, but it will be less profitable if the Bank of England negative interest rates take effect.

Credit card users- for new customers, credit card rates should be lower. However, once the introductory period ends, it could substantially rise above the base rate in the UK.

When Are The Interest Rates Going Up?

     A question that has been on every investor’s mind this year is ‘When are the interest rates going up?’ While it seems a simple enough question, the answer is rather complicated. Still, we are going to do our best to answer it here.

 Negative interest rates worked well in Switzerland and a member of the Bank of England’s MPC (Monetary Policy Committee) suggested that it could have a similar impact in the UK. If implemented, this would create an unprecedented situation in the UK. This means, people could be charged by the bank or financial organisations for having a savings account. At the moment, the base rate in the UK is at 0.1%, and lenders are offering low interest rates . If a negative interest rate is applied, the base rate could be at, for example, minus 0.25%,  and average mortgage rates could be fall to less than 2%. The UK inflation rate for 2021 is expected to be around 1.2% and, combined with the negative interest rate, savers will lose both nominal and the real values of their money. However, this policy could increase lending, investments, spending, and houses purchases in the country.

While it’s impossible to precisely predict when interest rates will go up in the UK, there are some indicators to look for that could indictae when interest rates might go up:

Global Economic Recovery- the global economic recovery could trigger higher interest rates in the UK. If the global economy starts to recover in the second half 2021 and into 2022, the Bank of England may relax the interest rate restriction, and rates may begin to rise.

Higher Rate Of Inflation- the UK inflation rate is still under the predicted target (in November 2020, it reached a record low of 0.3%). The official target is currently at 2% and if inflation begins to rise again, the Bank of England may allow a higher interest rate to prevent the rate of inflation from escalating further and exceeding the target by too much.

Good UK Economy- when the UK economy recovers, we could immediately see a higher interest rate. In 2020, the coronavirus pandemic caused another round of recession in the UK and the economy shrank by almost 20% between April and June last year. Following the third national lockdown in 2021, the UK economy is still struggling. Economic growth will remain weak in 2021, but once we see indications of an improving UK economy, there’s a strong chance that interest rates will start to rise.

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Written By RWB Wealth

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