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Negative interest: It's worth paying attention to our super low base rate

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of first direct.

Guy Shone

Guy is a business commentator, leading global researcher and market analyst. He’s made complex stuff seem simple to a global audience of 50 million people through many TV and radio channels over the past year. He’s all about explaining the market as simply as possible. This insightful piece is no different as we all navigate these unprecedented times.

Time to read:
8 minutes 

Negative interest: It's worth paying attention to our super low base rate     

Interest rates were slashed back in 2009 and they have stayed super low ever since. There was a time when people seemed fascinated by the prospect of interest rates rising again. TV news crews camped outside the Bank of England as though waiting for a plume of white smoke signalling a reset back to normal. Not so now. The Great British public has grown used to rock bottom interest rates. 

Our tiny base rate has come back into sharp focus again following the impact of Covid-19. So why should we bother paying attention?

The financial impact of the pandemic has already caused millions of businesses and families to look for more ways to save and keep track of their money. The Bank of England base rate can make a difference to our mortgage payments and any earnings from our savings.

The base interest rate dictates how expensive it is for retail banks (the banks we use) to borrow money from the Bank of England. This can have an influence over the rates banks and other lenders offer for products like mortgages or the interest savers can earn. Despite this impact though it is worth explaining that the base rate is just one factor banks need to consider when deciding how much interest to put on our financial products. They also need to take into account other money market rates, their legal and regulatory requirements and, of course, the cost of providing the product

Who decides on the change, and what does this mean for banks?

The base rate is decided by the Monetary Policy Committee (MPC), who meet roughly every 6 weeks. The most recent MPC meeting was on 18 June 2020 and they decided to keep the base rate at 0.1%. However, they can also make changes outside of the usual schedule, so a change can happen at any time they feel necessary.

If the Bank of England did decide to set its base rate to below zero, high street banks would have to pay to deposit cash with them. As such, a negative base rare is designed to discourage them from doing so, so they will likely be more keen to lend money to businesses and consumers to help stimulate the economy.

Whilst a drop to a negative base rate is possible, the Bank of England would need to reassure themselves that it would truly help and not simply cause more problems. Negative interest rates can stimulate the flow of money, they can also (in theory at least) cause customers to pull money from their savings accounts to try and find better returns elsewhere.

How could a negative base rate impact your mortgage?

Current interest rates are at historic lows so people understandably may be thinking about whether to try and lock in a great rate with a fixed mortgage now.

Last year in Denmark, the world’s first mortgage with a negative interest rate became available at -0.5%. Ever since then, journalists have been speculating as to whether a drop to a negative base rate in the UK could see mortgage providers making similar moves.

If you have a variable-rate mortgage or a tracker, your rate could fall a little if the base rate is cut. However, often the terms and conditions of the product provide for the limits of any fall.

Customer pros & cons of negative rates:

Generally speaking, the upside of negative interest rates is that people who need loans and mortgages may be able to get products for cheaper. The big worry though is that savers could start withdrawing cash from banks in order to look for a bigger return elsewhere and that could limit the amount which banks are, in turn, able to lend. It might also cause savers to take more risks than normal.

All things considered - How are banks coping with super low rates? 

Super low interest rates generally aren't great for banks. They reduce the size of the profit margin on lending products and some banks also worry that customers might withdraw savings in the hunt for better returns. However, despite the headlines, millions of savers appear to be focused more on the long term than the short term turbulence. Banks delivering excellent customer service can still inspire trust during these testing times. 

One good reason for keeping your money in a savings account is security. The FSCS (Financial Services Compensation Scheme) protects the money you hold in a bank, building society or credit union. The guarantee covers up to £85,000 of eligible deposits per person per bank and up to £170,000 for joint accounts: Something even the most secure mattress can't offer!

The economic risks of going sub-zero

Keeping rates low is a tried and tested method of encouraging banks to lend and people to spend. One problem comes though when rates stay so low for so long that policy makers feel they are running out of wriggle room to try and deal with any unexpected events in the global economy. 

One tactic governments can use is to help by agreeing to get money flowing another way. Stimulus has been widely used during the Covid-19 crisis by central banks around the world and it is likely that before the Bank of England even consider dropping rates sub-zero, they would want to try another big cash boost to the UK economy - potentially as much as £100 billion. But for now, we will just have to wait and see… 

Low base rate Key take outs:

  • Encourages lending and spending in an economy
  • Can positively impact mortgage rates - so check you’re on best rate for you
  • Can negatively impact savings returns - but savings in banks are still safer than using your mattress to hide money
  • Negative interest rates create a set of different issues (read economic risks of going sub-zero to find out more) 

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