🔔 Negative interest rates: three scary words

Author: Dan Darragh
28th February 2013

Deputy governor of the Bank of England, Paul Tucker, has scared the wits out of savers with his talk of negative interest rates.  Surely, interest rates are low enough we hear you cry.  Won’t negative rates just make things worse?  ‘Yes’ seems to be the answer.

First off, what exactly are negative interest rates? 

Banks and building societies currently earn 0.5% if they deposit money at the Bank of England.  But a negative rate would mean they have to pay the Bank of England to look after their cash.

Why would they do that? 

Well, that is what Bank of England might be betting on.  If banks do not want to pay to park their cash, hopefully they will put it to better use.  In other words, the mere threat of negative rates might prompt lenders to do what they are supposed to do: lend to homebuyers and businesses.

The flip side is that if general rates move even lower, savers will likely come off poorly.  But it need not mean they too must start paying banks to look after their cash.

In 2009, the Swedish central bank (the Riksbank) sent the financial world into a tizzy by lowering one of its rates to -0.25%.  But this is where the tricky stuff comes in.  The rate only applied to certain money held at the Riksbank.  The more important repo rate (used by banks for shorter term liquidity) remained positive.

But, as we are painfully aware, the UK Base Rate hasn’t moved a jot for nearly four years whilst savings rates have dropped.  So far this year savings providers have already announced rate cuts to over 270 existing savings accounts, with a whopping 129 planned cuts in March alone!

Any whiff of a negative rate might be the excuse banks need to cut rates further.  If they have to cut mortgage and business lending rates to encourage economic growth, savers are likely to suffer as a result, whatever happens to the Base Rate.