The Impact of Negative Interest Rates

Published / Last Updated on 11/02/2021

The Prudential Regulatory Authority (the regulatory part of the Bank of England) that regulates the UK banking industry has written to banks and building societies telling them to prepare for negative interest rates.

What are negative interest rates?

Firstly, let’s look at positive interest rates:

  • When you borrow money you pay interest on the money that you have borrowed.
  • When you save money you are paid interest on those savings deposited.
  • When Banks deposit money with the Bank of England for safekeeping, the Bank of England pays interest, currently 0.1%pa.
  • Higher interest rates strengthen the pound meaning imports are cheaper.

Now imagine base interest rates have gone negative, will it be the reverse of the above?

  • When you borrow money you would now expect to be receive interest on the money that you have borrowed i.e. banks pay you to borrow money.
  • When you save money you would now expect to be charged interest or fees on those savings deposited.
  • When Banks deposit money with the Bank of England for safekeeping, you would expect the Bank of England to charge based upon the negative base rate.
  • Lower interest rates weaken the pound meaning imports are more expensive.

In short, negative interest rates, unprecedented in the UK would:

Encourage people to borrow even more money and spend it in the economy, property, cars, goods and services.  Thus boosting economic activity and creating inflation.

Encourage people NOT to save cash on deposit in banks or building societies.  People that want to save will more likely be pushed into market related investments driving stock markets up or spending those funds thus creating inflation.

Banks will be encouraged to lend even more to businesses and consumers at cheap deals rather than ‘hoard’ it with the Bank of England.

  • A weak pound will drive FTSE stocks up as it will mean bigger profits as many FTSE companies earn their profits overseas in € or $ meaning even greater profits when converted to sterling.
  • A weak pound will mean imported goods are more expensive again driving up inflation.
  • Inflation = cost of living goes up = demand for wage rises go up = property prices rise.
  • Inflation = public sector debt is devalued without ever repaying it. 

We believe inflation is now the target of most governments to devalue covid-19 debts over say a 10 period.  E.g. 5% pa inflation compounded over a 10 year period is 62%.  This would mean a devaluation of national debt across nations.

What have other countries done?

  • UK base rate is currently 0.1%pa.
  • Japan is -0.10%pa.  EU is -0.5%pa.  Denmark -0.60%pa.  Switzerland is -0.75%pa.
  • In the EU, most banks are not passing costs onto clients.  That said, in Germany savers are charged for holding above €100,000 on deposit.  If they ‘stash’ paper notes in vaults or brick them up in the wall or buy gold, there is still a risk of flood, fire and theft.
  • In Switzerland, savers are charged for holding more than 2m CHF on deposit.
  • In Denmark, some banks are paying people to borrow more on credit.

We must expect similar results to any of the above in the UK if interest rates do go negative.  We expect more stock market investment, more property investment and inflation.  The one problem we do see is that of Building Societies.  Under the Building Societies Act 1986 and subsequent amendments, societies are required to ‘borrow’ at least 50% of funds from savers to then lend to borrowers.  If savers start withdrawing funds due to being charged for having money on deposit, this may have serious cash flow issues for societies and reduce mortgage lending capacity.

We live in extraordinary times.

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