Negative interest rates

The Bank of England has signalled the potential for negative interest rates in the future. What could this mean for borrowers and savers?

The Bank of England has signalled the potential for negative interest rates in the future. What could this mean for borrowers and savers?

Rob Silvey
Money expert
minute read
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Posted 2 JULY 2021

What are negative interest rates?

Negative interest rates are interest rates below 0%. For savings customers this would mean that instead of putting your money into a savings account and earning interest on it, you’d potentially have to pay the bank or building society for looking after the money for you.

So, for example, if you put £1,000 into a savings account paying 0.1% interest, at the end of the year you’d earn £1 in interest. If the savings rate was -0.1%, at the end of the year your deposit would have reduced to £999.

Why might we see negative interest rates?

Current interest rates are at a historic low, with the Bank of England rate close to zero. The Bank of England sets its interest rate independently of the government and aims to keep inflation at around 2% by using interest rates to influence the economy.

If interest rates are high, it’s expensive to borrow. So consumers and businesses may be less willing to do so in order to spend. But higher rates benefit savers, so people may spend less and put more money away.

Low interest rates, on the other hand, can stimulate the economy by making it cheaper to borrow to buy things and discouraging saving.

With the coronavirus pandemic and lockdowns, it’s been harder for people to spend money, particularly on leisure activities. Businesses have had to close, which has had an impact on the economy. If the Bank of England wants to stimulate the economy by reducing historically low interest rates, the only way to do so would be to go below zero.

Why does the Bank of England rate matter?

The Bank of England bank rate influences the rates charged on loans and paid on household and business savings. It also affects the exchange rate of the pound against other currencies and a range of asset prices set by financial markets. The interest rate is a lever that that the Bank of England can use to affect the economy both domestically and internationally.

In February 2021, the Bank of England told banks and building societies that they had six months to get ready for the possibility of interest rates going below zero, sending a signal to the UK that they’re considering using negative interest rates. However, Andrew Bailey, the Bank’s governor, stressed that there was a difference between having negative rates as part of its toolkit and actually using them.

How low could interest rates go?

It’s hard to say at this point. It depends on how effective negative rates are as a policy, but will also depend on much wider issues, like how the UK economy and the rest of the world recovers from coronavirus lockdowns, travel restrictions and so on.

Denmark, Sweden, Japan and Switzerland are among the countries that have tried using negative interest rates since 2012. As yet, none of them have gone below -1%.

How would this affect savers?

Negative interest rates could mean that savers end up paying banks and building societies to keep their money safe for them. Things will be slightly different if your money is in a fixed rate savings account. In this case, the interest rate will stay the same until the end of the fixed period – however long you signed up for.

But if your savings account has a variable rate, you may potentially have to pay to keep your money in it.

It could be that banks and building societies decide to only charge savers with large amounts of money and that most savers will simply get no interest. For example, in Denmark, Danske Bank has put thresholds in place. Cash balances below the threshold will carry interest of 0%, but an interest rate of -0.60% per year will apply to balances over a certain amount.

How will negative interest rates affect borrowers?

A negative bank rate doesn’t mean that borrowing rates will necessarily turn negative.

When deciding to lend you money, lenders take a lot more into account than the Bank of England rate. Things like your previous credit history and how likely you are to pay back what you’ve borrowed all come into play.

According to the Bank of England: “A modestly negative policy rate would not translate into negative borrowing rates for households and businesses, but would intend to lower them compared to a scenario with a positive policy rate.”

Essentially this means that mortgage and loan rates may be lower than they are at the moment, but wouldn’t be negative. Negative rates for borrowers would be highly unlikely to happen because lenders need to pay for their staff, offices and systems and also make a profit for their shareholders – so they need to cover these costs with interest rate charges.

You can see from the advertised rates that despite the close to zero bank rate, rates for loans and mortgages are far higher. This gap between the lower bank rate and the higher rate consumers and businesses are offered is likely to remain.

What will happen to my mortgage?

This will depend on what kind of mortgage you’re on, if and when interest rates change. If you’re on a fixed rate mortgage, nothing will change, whether rates go up or down. However, when you get to the end of the fixed rate, it could make sense to remortgage to see if you could get an even lower rate.

If you’re on a variable rate mortgage, you may find that your interest rate goes down, but that isn’t a guarantee. Mortgage lenders still need to make a profit and some high-street lenders have warned that negative rates may result in them having to put up rates to protect their profitability.

Banks and building societies make their profit by charging a higher rate of interest to borrowers than they pay to savers, and potentially negative rates would lead to a narrowing of this ‘spread’, reducing overall profits. If they don’t pass on the negative rates to savers, lenders may find themselves putting up rates for borrowers.

And don’t forget, mortgage lenders are looking long-term as mortgages typically run for 25 years, so they will still price in the risk of people defaulting on their mortgage payments.

Will negative interest rates affect loans and credit cards?

Potentially, but probably not by much. You might find that more cards are offered with low introductory rates or that 0% rates last for a little longer.

The majority of personal loans (or unsecured loans) have a fixed rate of interest. This is based on your creditworthiness as well as the bank rate, so it’s unlikely to change. But some people with good credit ratings taking out a new loan may benefit from slightly lower rates.

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