What is a Negative Interest Rate?
Record low interest rates in the light of the pandemic have raised the prospect of businesses and the UK economy having to deal with Negative Interest Rate at some point. The Bank of England has stressed that such a move is not imminent, but, so that WMB readers can be equipped for every eventuality, Emily Newport, Insight Analyst (Economy) at Warwickshire County Council, outlines the potential impact.
What is a Negative Interest Rate?
The nominal interest rate ordinarily decides the percentage charged for borrowing and the percentage rewarded for saving/lending which is determined by the bank rate set by the Bank of England. This has recently been set to a record low rate of 0.1% in an attempt to encourage spending and borrowing, rather than saving, during this period of incredibly low economic activity.
Historically in the UK, the interest and bank rate has always been positive, but more recently the Bank of England have suggested that whilst its use is not imminent, having a negative interest rate is something they have in their toolkit to encourage economic growth.
Negative interest rates are an unconventional form of monetary policy which has been used in a few countries, including of Japan (January 2016) and Switzerland (January 2015) , and involves putting the interest rate below zero.
If the Bank of England applies this, UK banks and other financial institutions will be under pressure to pass this rate on to their customers to ensure they remain cost-effective. This would put building societies in particular, due to the dependence on savings, in a compromising position.
Why are we concerned with Negative Interest Rates Now?
As mentioned above, whilst the Bank of England have said the implementation of negative interest rates are not imminent, if at all, they have asked if banks and building societies could be prepared to implement them by the end of the summer.
The latest from the Bank of England suggests that the UK economy will have recovered by the end of 2021, back to its end of 2019 position, meaning they may have to pull out all the stops to get there given the near 10% drop experienced over 2020.
In implementing negative interest rates, the intention would be to avoid businesses and individuals choosing to sit on capital and instead encourage them to spend, invest, and lend the economy towards recovery. That being said, this is only one potential tool that would be used in a larger package of economic recovery measures to stimulate growth.
If the bank rate drops below zero, this means the gap between the total money that financial institutions make on loans and the reward they pay to savers will reverse, close and ultimately be less profitable using their current interest rates. In order to remain sustainable, they will be forced to pass the new negative bank rate on to consumers.
Consequently, loans and borrowing will be made profitable, whilst savings will be discouraged and chargeable. At a micro level we could expect this to impact: Variable rate mortgages and rent, as the amount owed per month would be less; savings as these become chargeable, though it is likely to impact the wealthier more; borrowing and loans which will become cheaper and profitable.
Property will become more affordable, and spending and banking habits will change to adapt to the new rate.
It is important to note that many financial institutions will want to remain competitive and may be hesitant to pass negative rates on to their customers. Furthermore, there may be a variety of existing terms and conditions that prevents the passing on of a negative interest rate.
Further to this, the interest rate also has macro level effects on inflation, causing it to rise, thus increasing the cost of living. It also depreciates the currency value, reducing Foreign Direct and imports as the UK becomes less profitable and attractive, but making UK exports more competitive as they appear more affordable.
Emily Newport (email@example.com)