Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
A few things emerged from the Bank of England’s latest monetary policy report. The good news is that the Bank expects a rapid vaccine-fuelled recovery in the second half of this year. The bad news is that it forecasts UK gross domestic product (GDP) to fall 4% this quarter, though GDP was somewhat stronger than expected in the final three months of last year. The somewhere-in-the-middle news is that commercial banks will now be given six months to prepare for negative interest rates.
It’s unclear what to make of this. The Bank explained that this should not be seen as a sign that interest rates will turn negative. This is simply contingency planning. But, as is the nature of contingencies, such planning implies negative interest rates could still happen.
Nevertheless, the good news here outweighs the bad. We now know that even if interest rates were to take a dip below zero, it wouldn’t happen for at least six months. By that time, the hope is that there won’t be any need to use negative rates anyway. The prospect of an economy reopened by vaccines and revitalised by households’ accrued savings should be enough to buoy growth. Positive GDP predictions and bearish news on negative rates tell us much the same thing.
Reading between the lines, the decision to give banks six months to prepare tells us there’s little consensus among the Monetary Policy Committee over the merits of using negative rates. It’s not hard to see why.
The basic idea behind negative interest rates is to incentivise spending. The BofE puts the ‘base’ rate the Bank pays to commercial banks on their deposits below zero. That should push commercial banks to take money out of the central bank (here, the BofE) and into the economy via loans to people and businesses. Commercial banks might even apply negative rates to their own customers, giving people added incentive to get out and spend.
If low interest rates are the carrot - where borrowing money is as cheap as possible - negative rates are more like the stick - it actively costs you to save your money.
There are problems. First, it looks as though there is a limit on the extent to which banks can pass on negative rates to their customers. Most will not pass on a penalty interest charge. At the same time, the amount they can charge on loans is reduced. Their profits are squeezed, and they consequently reduce the amount of available credit at precisely the time when the economy needs it to be increased.
That’s why shares in banks rose yesterday - bad news for negative interest rates is good news for banks.
There are also concerns over a so-called ‘reversal’ rate of interest, below which people are not encouraged to spend but are suitably spooked by the negative environment to actively avoid spending!
And while you may hope negative rates mean your mortgage balance would be dropping all on its own you will be disappointed. New mortgages are often fixed for a period - when the rate stays the same - before a standard rate pegged to the Bank rate kicks in.
Negative rates could lower the rates on new mortgage deals, but most home loans include clauses to prevent the interest turning negative, and some may not be linked to the Bank rate at all.
Yesterday’s news, then, is good. It tells us that the Bank is still sceptical. It also tells us we will have ample warning if the decision is taken. This six-month window gives us all time to look at our investments and consider how well protected we are in a changed environment. The same rules as ever apply. Be diversified. Maintain a long-term view. Don’t panic.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.