Britain’s savers could soon be charged to hold money with their banks after the Bank of England left itself open to setting interest rates negative for the first time.
The Bank of England base rate of interest, which influences how cheaply banks can borrow money, what homeowners pay for their mortgage and how much savers earn on their savings, was held at its historic low of 0.1 per cent yesterday.
But experts are now warning a negative base rate looks plausible if the economy stalls in the face of soaring unemployment or a second wave of Covid.
If the Bank of England moved to push rates into the red, then commercial banks would have to pay to hold cash deposits with them, making it likely most if not all would pass on these costs to savers.
On the flipside, those on variable rate mortgages that are linked to the base rate could see the unusual scenario of their bank technically obliged to pay them interest on their homeloans.
The country’s hard-pressed savers could soon see their savings eroded even further
In practice, however, history suggests that negative rates tend only to be passed on to savers, while mortgage borrowers see no benefit.
In the aftermath of the credit crunch, this was the case for a small number of mortgage borrowers, who simply didn’t have to pay interest at all.
The increasingly real prospect of negative rates will come as a further blow to the country’s hard-pressed savers, who have already had to endure a decade of low interest rates, and could soon see their savings eroded even further.
Challenger bank Starling has already dropped its interest rates for personal account customers below zero this week, though only for those who hold high balances in euros.
This is because the European Central Bank has had a policy of negative interest rates since 2014 but cut rates from -0.4 per cent to -0.5 per cent last year.
Kevin Brown, savings specialist at Scottish Friendly, said: ‘The prospect of the Bank of England coming to the rescue of the nation’s hard pressed savers remains a long way off, with today’s announcement possibly paving the way for negative interest rates in the coming months.
‘Although the steep drop in inflation in August means there is temporarily more choice for savers looking for inflation-beating returns, this period is likely to be short lived.
‘The cash savings market in the UK is beyond repair while the prospects for the UK economy remain so uncertain.’
What would it mean for savers and borrowers?
The economy grew by 6.6 per cent in July, which experts said puts the economy on track for a double-digit bounce-back from recession.
But worries are mounting over mass unemployment and long-term economic scarring following the pandemic once Government support schemes end.
If the economy starts shrinking again, in theory negative interest rates would stimulate more spending by encouraging banks to get money out of the door to businesses and consumers to spend, rather than save.
Bank Governor Andrew Bailey said recently he expects the pandemic to permanently scar the economy by reducing GDP by 1.5 per cent
It may also mean borrowing – for example taking out a mortgage – will become cheaper.
Central banks in Denmark and Switzerland have already set interest rates below zero, with Denmark’s third-largest lender Jyske Bank hitting the headlines last year after launching a mortgage with a rate of -0.5 per cent, the world’s cheapest.
This meant the amount a borrower owed the bank reduced each month because it deducted rather than charged interest. It wasn’t free money though, as the bank still profited from fees and charges.
There is also no guarantee that all banks would pass on the benefit in the same way, and lenders are usually slow to pass on interest rate cuts to borrowers.
They are also already operating on very slim margins and a further base rate cut would give them even less room for manoeuvre on pricing new mortgage products.
Mortgage holders already on variable rates should mostly start saving money every time interest rates are cut. Whether UK lenders would follow Jyske Bank in launching negative mortgage rates remains to be seen.
The opposite is true for savers – banks could pass sub-zero interest rates onto customers by charging them to hold their deposits.
All nine members of the MPC voted to leave rates unchanged and keep its quantitative easing programme to boost the economy at £745billion
Rachel Winter of Killik & Co, said: ‘The rumours of negative interest rates continue to rumble on but, in welcome news for UK savers, they are yet to become a reality.
‘However, there remains the prospect of significant job losses when the furlough scheme comes to end next month which will inevitably put further pressure on household finances, so the possibility of lower rates in future cannot be ruled out.
‘As we have seen over the past decade, lower interest rates can have the effect of enticing more savers into the stock market as they seek to earn a return on their savings.’
While Britain’s biggest banks pay everyday savers as little as £1 on every £10,000 of savings already, costing them money in real terms after inflation, actually penalising them for holding their money would be unprecedented.
Inflation remained well below the Bank’s 2 per cent target in August – plunging to just 0.2 per cent – meaning there is no official case at the moment for an increase in rates.
However, many believe the Bank of England could implement further action later this year, likely in the shape of more bond-buying in November or December to prevent the economic rebound from fizzling out.