Earlier this month, the Bank of England made a series of announcements after its Monetary Policy Committee meeting. It said it was keeping interest rates at a historic low of 0.1% amidst the Coronavirus pandemic. Most notably, it also announced that high street banks and building societies should be aware of the potential for negative interest rates. In fact, it has asked those companies to be able to implement negative interest rates, should the Bank of England announce that it was cutting interest rates to below zero.
But, in reality, what does that mean? What exactly are negative interest rates, and how will they affect the average saver and pensioner?
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What are negative interest rates?
In theory, a negative interest rate would mean that if you were to lend someone money, you would have to pay to give them that loan. As such, it sounds a little counterintuitive, but when it comes to the Bank of England announcing they may implement negative interest rates, it is slightly different.
The Bank of England sets a base rate that determines how much interest banks and other financial institutions have to pay to borrow or lend money with it. From there, those financial institutions can then set their own interest rates to borrowers and savers on the financial products it is offering.
Changing the base rate is one way the Bank of England can help change the UK’s money supply. In times of recession, they usually lower it to encourage people to save less and spend more. As such, it has sat at 0.1% since March 2020 when Covid-19 restrictions started wreaking havoc on the economy.
How will negative interest rates affect me?
Given the potential for negative interest rates to come into effect in the next six months or so, it’s good to know how they could affect you.
If you are a saver, you will see your returns on savings accounts go even lower than they already are. Savings accounts have long offered pretty paltry returns as the base rate has been so low since the financial crisis back in 2008. Negative interest rates will push them lower as banks will not be able to afford to offer higher ones. The difference between the Bank of England’s base rate and the interest rates that banks offer on their savings products is where they make their money.
If you are a borrower, negative interest rates could have a very positive effect on you. For most of us, it will or could impact how much our mortgage repayments are. By taking the base rate lower, the Bank of England allows banks to offer cheaper rates to their customers - yet still allowing those banks to make a profit. However, in the past, banks have been historically slow to implement lowering mortgage or loan rates.
How will negative interest rates affect pensions?
The complexity of negative interest rates can, to a certain extent, affect pensions, but not directly. The impact will be caused at a broader economic level.
The Bank of England is considering lowering interest rates into negative territory to stimulate the UK economy and ensure that a bigger recession does not occur. That in itself is a good thing for pensions as a growing economy is often reflected in stock markets and share growth.
However, some of the side effects could be negative too. International investment may decline in the UK as it may be seen as an uncertain place to pour cash into. That can negatively affect the economy, which has repercussions on pensions invested in pension funds.
Of course, the other idea to consider is where and how you have saved for your pension. If you have your pension in a pension fund that is heavily invested and also diversified, doing so will hopefully have mitigated against any wider risks that can minimise losses. However, if you have a great deal of your money saved in a Cash ISA and were banking on it growing at a certain interest rate, the introduction of negative interest rates could affect that.
Proposed negative interest rates in the UK
While the notion of negative interest rates in the UK may sound shocking, they have already been implemented in several countries worldwide. Since the credit crash in 2008, even developed economies have been trying to stimulate their GDP to grow by employing many different techniques from central banks. In truth, there are so many factors at play when it comes to economic growth, that negative interest rates may have a positive effect overall.
But they could also have a negative effect, depending on the circumstances in which they are introduced. Bearing in mind that we have been experiencing almost a year of lockdown restrictions around the world now, it is simply too early to say where the UK economy will be in six months.