Negative interest rates

There has been a lot of speculation recently around the possibility of the UK’s interest rate becoming negative, meaning that banks and building societies would be charged to hold money on deposit with the Bank of England.

This would be the first time the UK interest rate has ever been negative, although several countries, including Switzerland and Japan, have tried this option, and the European Central Bank has had a negative interest rate since 2014.

Current interest rate

The Bank of England reduced the UK interest rate to an all-time low of 0.1% in March 2020, in response to the deteriorating economic outlook caused by the Covid-19 pandemic.

The rate had been gradually reduced from 5.5% down to 0.5%, following the global financial crisis in 2008, and was then cut further to 0.25% in August 2016, following the Brexit referendum. Prior to the pandemic, the Bank of England had started to normalise the interest rate, with increases to 0.5% in November 2017 and then 0.75% in August 2018.

The Bank wrote to high street banks in October 2020 to query how ready their systems were to deal with a potentially negative or zero interest rate, showing that this option was under consideration.

What would the implications be?

The main reason for cutting the interest rate further would be to stimulate the economy by encouraging banks and building societies to lend more money. This measure is therefore unlikely to happen while lockdown remains in place and spending is restricted, but could be introduced later in the year.

In theory, this could mean banks and building societies charging their retail customers for current accounts and savings, but in reality, this is very unlikely as a substantial number of people would simply withdraw their money.

It is also possible that individuals with a tracker mortgage could end up being paid interest by their lender, but again this is unlikely as most lenders have a clause that their rate cannot reduce below zero.

What is likely is that interest rates on savings, already close to zero, would reduce even further. Inflation has fallen to just 0.4% (CPI for February 2021) but is expected to increase again, reducing the actual value of savings over time.

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This article is for information only and should not be construed as advice or a recommendation. You should always seek independent financial advice prior to taking any action.

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