All eyes will be on Bank of England in the coming months as they decide whether further cuts are required to the UK’s base rate of interest. A decision to cut rates again may give the economy a much-needed extra boost, but it would also move the UK closer than ever towards a 0% base rate. So, will rock-bottom rates become a reality and, if so, what will it mean for you?
What has happened so far?
In August, a unanimous vote by the Monetary Policy Committee (MPC) saw a drop in the base rate to a new historic low of 0.25% and the start of further cash-injections into the economy (known as quantitative easing [QE]), in a bid to stave off a post-Brexit recession. This appears to have had some positive effects, particularly in boosting the price of UK stocks and bonds, but it’s too soon to say how it will affect the real economy in the longer-term. The rate drop also contributed to less foreign investment coming into the UK as people moved their money to countries offering higher returns, causing the Pound to drop to a lower level than it was after its post-Brexit pummeling.
Will lowering interest rates again work?
The theory is that additional rate cuts will make the cost of lending even cheaper, which should encourage individuals and businesses to borrow money which they spend on goods and services. Low rates effectively penalise people for hoarding cash, since any savings will be losing value in real terms, particularly with inflation at current levels. Whether a further rate cut will make much difference, however, is debatable. Some even think that far from boosting spending, it could have the opposite effect, encouraging savers to take money out of the banking system altogether and put it under the proverbial mattress, or in a safe. That would be bad news for the MPC’s plans to boost lending, since much of the cash banks have available to lend comes from customer deposits. Unsurprisingly, there’s much disagreement over whether the MPC will go to the lengths of a further rate cut, not least because it’s such an unpopular decision amongst the millions of Britons trying to save for a house deposit or retirement.
Could rates drop to 0% or lower?
It’s possible. Already, several European countries including Sweden, Switzerland and Denmark are experimenting with negative rates and some think they are heading for the UK. However, success to-date has been questionable, in some cases weakening the economies they are supposed to be helping by encouraging investors to take their money elsewhere. Further afield, Japan has suffered a 4-year stint of negative rates, with little to show for it despite massive investment by the government. Back in the UK, savers may take some reassurance from the fact that Bank of England Governor, Mark Carney has openly said he’s not a big fan of negative interest rates.
If rates go negative, what happens to savings, mortgages and loans?
As usual, it’s savers who will suffer the worst. When the rate was cut to 0.25% in August, banks and building societies wasted little time in slashing savings rates, with many easy-access cash accounts dropping to as low as 0.01% p.a. 1 Any further rate drop will no doubt be seen as a green light by lenders to make additional cuts and increase their margins at the expense of already besieged savers. But will negative rates turn the system on its head and prompt banks to start charging savers interest on their cash? Most think it’s unlikely, although banks will need to recoup their profits from somewhere and the most likely target is business customers. In July Nat West Bank wrote to 850,000 business customers warning them of the prospect of charging for deposits, although they said they had ‘no plans’ to extend that to personal accounts. Consumers, in any case, have a distinct advantage in that they are highly fought-over by the banks, so it would be a bold move for any of the ‘Big Four’ to be first to declare their intention to charge retail customers to hold their savings. More likely is that banks will swallow further cuts, at least for now.
Whether mortgage customers will see any further drop in interest on their repayments, depends largely on the terms of their agreement. In 2015 almost 90% of new2 mortgage customers chose a Fixed rate product on the speculation of forthcoming rate rises, so if you're one of those, nothing will change for you. Even Tracker mortgage customers need to read their small print. Many lenders impose a ‘collar’ on the rate that prevents it dropping below a minimum level. New mortgage customers are unlikely to be better off either, given many banks have been reluctant to lower their standard variable rates since the August rate cut, despite strong persuasion from the Bank of England Governor. The same can be said for personal loans – lending rates have begrudgingly come down over the past three years, but the best rates remain well above the 3% mark3 and are unlikely to fall much lower due to the banks’ reliance on them as a source of income.
In short, even if another rate cut were to materialise, it’s unlikely to translate into lower monthly repayments for most mortgage or loan customers or make anyone feel significantly better off in the short term. Perhaps the most meaningful effect on consumers of a further cut would be to make people sit up and take notice of the interest rate they’re earning, and perhaps do something about it. There’s currently 11 million cash ISA accounts held in the UK, the majority of which are likely to be earning returns well below the current level of inflation. If another rate drop encourages some of those savers to look at their finances and consider alternative ways to make their money grow, such as through investing, it will help a lot of Britons to make their financial futures more secure.
Please remember that the value of your investments can go down as well as up and you can get back less than invested.
1This is Money 22/10/16: http://www.thisismoney.co.uk/money/saving/article-3862050/Low-rates-rising-inflation-mean-misery-savers-s-Chancellor-end-injustice.html
2Independent.co.uk 3/8/16: http://www.independent.co.uk/news/business/news/interest-rate-cut-decision-reduction-mortgage-repayments-bank-of-england-mark-carney-a7170526.html
3Correct as at 31/10/16 source Go Compare / Love Money: https://money.gocompare.com/loans?media=GG003&device=c&gcclickid=ec9afd1b-cd28-4e66-9c27-97f8d89fc7fe#/