BoE shows interest in negative interest rates

BECOME A MEMBER

Sub-zero rates just in time for winter?

TThe Bank of England is seriously considering the unprecedented step of negative interest rates. This is the first time such a move has been considered in the Bank’s 326 year history.

Some thought it was ‘forward guidance‘ when it was announced in the monetary policy committee meeting minutes. But Andrew Bailey has since made it clear though that the BOE are not about to push interest rates below zero in the near future. And if they did want to use negative rates at any time in the future, it needed to be sure that commercial banks were able to implement the policy and transmit it to markets without systems blowing up!

Wall of Worry

Debt wall

Despite the benefits of pent-up demand and an earlier than expected end to lockdown, the Bank has previously warned that Britain’s economy could shrink by a fifth in the first half of the year alone, and that unemployment could double to 2.5m. Back in May, the BoE forecast was that GDP could fall by about 14% this year but now the projection is that it will shrink by 9.5% in 2020.

However, the Bank Chief Economist Andy Haldane was concerned that negative commentary surrounding the economy would be self-fulfilling and called for more positive rhetoric. He considered that commentary on developments had been overly negative and that positive news had tended to be ignored. Especially given things have recovered faster and have shown far-greater resilience than anyone expected.

Andy Haldane

Now is not the time for the economics of Chicken Licken.

An overly-pessimistic popular narrative, which fosters fear, fatalism and excess caution.”

Andy Haldane – BoE Chief Economist 

The unholy trinity of COVID: a slowing economy, job losses, and Brexit.

Unemployment continues to rise, albeit not at the same pace as in March and April. This will change as furlough ends and will also make a rate rise less likely. Economic growth, or otherwise, will most likely be the biggest factor in determining the direction of interest rates. The economy is still 5% smaller than it was just a few months ago. Brexit continues to be the elephant in every room.

Then there is inflation, which is still well below the 2% target and could become negative in itself. The BoE would be inclined to cut rates under those circumstances.

Could rates begin to rise again?

Another obvious concern is rising interest rates. There’s been a lot of speculation lately over long-term interest rate increases, so caution here is prudent, but it certainly shouldn’t prevent you from making a move in the property market.

While it’s possible for interest rates to drop again (they’re currently at 0.75%, but were as low as 0.25% back in 2017), it’s is extremely unlikely in the foreseeable future. But does that mean the only way is up?

The Bank of England has published a detailed paper looking at real interest rates from 1311 to 2018.

interest rates
Real interest rates from 1311 to 2018

The graph shows that since about 1670 there has been a continual overall downward trend in real interest rates. Despite this trend, there have also been short-term interest rate rises. This is typically as a result of government policy decision.

What the data shows is that a rise would-be against the market trends and therefore is highly unlikely to be long term sustainable. In other words, there’s a greater probability that interest rates will go down than they can go up, and negative rates looking increasingly likely in the longer-term, if not the near term.

Pros and Cons of Negative Interest Rates

    • Directly benefits people and larger corporations as the cost of acquiring capital will reduce substantially
    • Cheaper access to credit facilities means more money in people’s pockets, resulting in increased consumption
    • The interest component of existing debt payments may shrink
    • The corporations, small-scale or a fully functional enterprise, will be able to raise funds on a much lower interest rate to boost their businesses.
    • There will have to be a substantial rejig in the primary business models of banks and they may start charging a fee for the deposits and will be keener on lending the credit
    • Banks will shift focus to borrowers
    • Some people would likely withdraw their deposits to avoid the extra charges and utilise the funds for other investments such as stocks, mutual funds, privately investments, and precious metals etc.

 

Cards

Risk mitigation means preparing for the unexpected

What can you do to mitigate the risk of a short-term interest rate rises? Fixing your mortgage for a decent period, with lenders are offering 10-year fixes at the moment, is one way. You will, however, have to take into account the higher rate you’ll have to pay and any repayment fees you’d incur should you wish to buy yourself out of the deal early.

It’s also a good idea to factor in higher percentages when calculating your potential property’s viability. Stress testing at a higher rate and understanding exactly what margin there can throw up some surprising figures. And it’s always better to be surprised before you’ve laid out your money than after!

You could start paying an increased interest rate before it happens to create an extra sink fund. After all, having a backup vault is always handy, regardless of what business you’re in.

BECOME A MEMBER

Sigh-up to get free insights that will help you Get Rich Slowly!