Sunday, 25 October 2020

Negative Interest Rates

As if savings were not in a bad enough place today, it appears that the Bank of England are going to introduce negative interest rates.

The central bank could take rates into negative territory as early as next month in a bid to prop up the economy as it reels from the Covid-19 pandemic.

The Bank has already cut rates to an all-time low of 0.1 per cent, hammering savers but making mortgages and other loans cheaper.

Evidence to the Bank of England shows that companies have chosen to increase investment rather than have their cash on deposit decline in value. However, UK banks have argued that IT systems are not ready to process negative rate deposits and loans. There are also concerns that if negative rates apply to personal deposits, customers will withdraw funds and keep them outside the banking system.

While real interest rates can be effectively negative if inflation exceeds the nominal interest rate, the nominal interest rate is, theoretically, bounded by zero. Negative interest rates are often the result of a desperate and critical effort to boost economic growth through financial means.

Negative interest rates may occur during deflationary periods. During these times, people and businesses hold too much money [instead of spending money]. This can result in a sharp decline in demand, and send prices even lower. Often, a loose monetary policy is used to deal with this type of situation. However, when there are strong signs of deflation factoring into the equation, simply cutting the central bank's interest rate to zero may not be sufficient enough to stimulate growth in both credit and lending.

Savers would appear to have three options: 1. save less and spend more 2. save more to compensate for lower returns 3. put their cash into riskier investments.

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