Of all the measures that the Government and Bank of England has on hand to boost the economy, there’s one that so far has been resisted - negative interest rates.
For most of us, the idea that a loan could have an interest rate below zero - so the lender gets back less than they lend out - makes no sense. Why would you agree to lend at all?
Yet negative interest rates already exist for the debt issued by some countries, and last week the UK issued its first ever long-term government bond (known as a gilt) with a negative rate, of -0.003%.
If the trend continues, it is even possible that the Bank of England will lower the official Bank rate - currently at 0.1% - down below zero. When asked about that, Governor Andrew Bailey last week said that he ruled nothing out when it comes to boosting the economy.
Why have negative interest rates at all?
Negative rates are a continuation of the ultra-loose monetary policy which has been in place for several years since the financial crisis, and which has been extended dramatically in the Covid-19 pandemic. The principle is that Central Banks make borrowing money as cheap as possible so that people are encouraged to borrow and spend, stimulating economic activity. Interest rates are cut and Central Banks buy assets - in a process known as quantitative easing - which has the effect of pumping more money and confidence into lenders and financial markets.
Pushing rates below zero is an extension of that, but while those other measures are carrots to encourage people to spend, negative rates are more like a stick. It will potentially cost you to keep money on deposit, so you may as well get out and spend.
Who wants to lend at negative interest rates?
When the European Central Bank moved into negative interest rates a few years ago, there was a spike in purchases of safety deposit boxes in Germany. If you were going to lose money by putting money in the bank, many Germans preferred to keep their money in physical form.
Large financial institutions, however, do not have the option of stashing money under the bed. The UK was only able to issue a negative-yielding gilt last week because there was a market of investors willing to buy it, effectively lending money at a negative rate.
Why would they do that? Institutional investors have to find homes for their money and many will be required to offset risk and liabilities on their balance sheet by buying ultra-safe assets like government bonds. They know they are accepting a loss, but the alternatives are either worse or do not offer the required level of security.
Negative rates also indicate that expectations for growth in the economy are now very low. One of the reasons investors accept such a low (or even negative) return from lending money is that they do not expect significant inflation, which tends to come when economies are growing more quickly. Because inflation will be very low, they reason, the money we have lent will largely retain its value.
What happens to savings and mortgages?
If you thought the bank might ring up to say your mortgage balance is now dropping all on its own thanks to negative rates, 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.
For savers, it’s more bad news. Returns on cash accounts have been very low for a long time and even the best deals have only occasionally beaten inflation. Negative rates may wipe the return from many accounts to practically nothing.
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. 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.