The Bank of England is a venerable institution. Not once since it was founded in 1694 have interest rates gone negative and there is no immediate prospect of that 327-year-long record ending.
To be sure, the most interesting piece of news from Threadneedle Street’s quarterly monetary policy report was that banks and building societies have been given six months to get ready for the possibility that rates might need to go below zero.
But a possibility is not the same as a probability, let alone a certainty, and the economy would have to be in a lot worse shape in August than the Bank’s nine-strong monetary policy committee expects to trigger such an unprecedented step.
In February 2021 the Bank of England told high street banks and building societies they have six months to prepare for negative interest rates. BoE policymakers stressed that the request did not mean a cut in borrowing costs below zero was imminent or even likely, but with few tools left to boost the economy in the event of a downturn, the central bank needs negative rates to be available as an option.
What would happen to my mortgage?
If it’s a fixed-rate mortgage, a cut in interest rates would mean no change. Most households are on this type of deal – in recent years about nine in 10 new mortgages have been taken on a fixed rate.
If it is a variable-rate mortgage – a tracker, or a mortgage on or linked to a lender’s standard variable rate – the rate could fall a little if the base rate is cut. But the drop is likely to be limited by terms and conditions.
Older mortgages often have a minimum rate specified in the small print. Nationwide building society, for example, will never reduce the rate it tracks below 0% on mortgages arranged since 2009 – so if your mortgage is at base rate plus 1 percentage point, it will never fall below 1%. Santander specifies in some mortgages that the lowest rate it will ever charge is 0.0001%.
You will need to dig out your paperwork to see how low your mortgage rate could go.
Will new mortgages be free?
In Denmark, borrowers have been offered mortgages with negative interest rates. Mortgage customers with Jyske Bank were lent money at a rate of -0.5%, which meant the sum they owed fell each month by more than the sum they had repaid. There is no reason why UK lenders could not follow suit.
What happens to my savings?
UK savings rates have already been affected by the two base rate cuts in March 2020 and many easy-access accounts from high street banks pay just 0.01% in interest.
Some banks already charge for current accounts, but it is unlikely that you will soon be forced to pay to keep small sums on deposit – despite the low base rate it is possible to earn 1% or more on a fixed-term savings account.
Wealthy savers are likely to be the first who would face a charge. In 2019, UBS started charging its ultra-rich clients a fee for cash savings of more than €500,000 (£449,000), starting at 0.6% a year and rising to 0.75% on larger deposits. And at Jyske Bank, similar charges apply.
What about my pension savings?
Negative interest rates are bad news for pension funds. If you have a defined contribution scheme you may find the predicted value on retirement falls, and you need to put more in if you have a target finishing date in mind. It is also a bad time to buy an annuity to provide a retirement income, as the returns on these fall when rates are negative.
All in all, the Bank is modestly optimistic about the prospects for the economy. Activity in the final three months of 2020 was “materially” stronger than it predicted in November and while the first three months of 2021 will be grisly, the envisaged 4% contraction will be much smaller than the near 19% drop during the first national lockdown last spring.
When the restrictions are lifted the expectation is for the economy to bounce back, helped by consumers spending a chunk of the money they have saved during the past 12 months. The City’s money markets might be pricing in negative rates, but by the time the financial system is ready for them the economy should be growing fast.
Instead, negative rates should be seen as an insurance policy in case things turn out much less well than the Bank is predicting, as is entirely possible. These are especially uncertain times, and nobody would rule out the risk that a new variant of Covid-19 might emerge that proves resistant to the current vaccines.
Andrew Bailey, the Bank’s governor, stressed that there was a difference between having negative rates as part of the toolkit and actually using them. Similarly, nothing should be read into the fact that the staff at Threadneedle Street have been told to draw up plans for how policy might be tightened in the future.
Negative rates would affect the balances of commercial banks held at the Bank of England. The interest rates on mortgages, overdrafts and credit cards would remain positive, in some cases markedly so. But moving to negative rates would still be a massive step, and one that would only be taken once the Bank has exhausted all other options.
