The Bank of England has so far resisted the urge to set negative interest rates in a bid to keep the UK economy going through the coronavirus pandemic.
In November 2020, the Bank of England kept its base rate at 0.1% for the eighth consecutive month and opted for a quantitative easing strategy, pumping £150bn ($198bn, €167bn) into the economy ahead of the second lockdown.
The UK has never entered negative interest rate territory before, but it remains a tool at the BoE’s disposal.
Neil Jones, technical director at Canada Life, said: “The idea behind negative interest rates is like that of quantitative easing in that it is a mechanism to encourage wealth to flow through the economy.
“If the BoE charges high street banks for holding deposits, their margins could be squeezed further as they lose returns, or even face negative returns for individuals and corporates holding cash deposits.
“This in theory would encourage people to spend money and if negative rate loans are available, even borrow, pumping more money around the economy.”
Given it is not something they have faced before, negative interest rates will inevitably spark panic for clients.
So, does the age-old advice of sitting tight and thinking of the long-term apply in this case? Or should investors be looking to make changes to their portfolios?
Steve Burns, managing director at Lewis Brownlee, said: “We don’t think this will make much impact at all. Negative interest rates are quite a headline moment for the press but not that impactful. It is similar to Y2K and whether computer systems could cope, but it isn’t going to impact invested clients much.”
Hannah Owen, financial adviser at Quilter Private Client Advisers, added: “Clients should see what the impact will be for them before making changes based on speculation.
“If negative interest rates are put in place, it would impact banks and they would decide whether they would need to pass this across to customers, likely in the form of fees for their bank accounts.”
A big part of a financial adviser’s role is to settle the nerves of their clients.
They can be a vital barrier to stop Brits from making knee-jerk mistakes or taking on unnecessary risks after being inundated with scary headlines.
Owen added: “Advisers should keep a close eye on what happens to mortgages, as this might drive mortgage demand. Negative interest rates will make it a good market for those who wish to borrow, rather than those who wish to save, and advisers can play a role in educating their clients on what their best course of action is, based on market forces.
“It provides a good opportunity to discuss cash risk, especially as some clients hold a lot in cash that is losing value in real terms due to inflation.
“It is also important to ensure clients still have an appropriate emergency fund but due to the pandemic more people are hoarding cash which is understandable but may not be the best course of action. Once an emergency fund is built up, it may be better to invest cash in other ways particularly if there are negative interest rates.”
Burns said: “I don’t think that advisers should make any major changes. Perception could be an issue with clients, investors typically think in nominal values, so while they may have been experiencing negative interest rates without realising it, a negative headline rate might have a physiological impact.”
Impact on pensions and investments
Negative interest rates will undoubtedly have an impact on mortgages.
But it could also influence the pensions and investments market.
Canada Life’s Jones said: “Inflation risk is always an issue and, as the cost of living is still increasing, if the value of cash deposits in real terms are not growing, or even going backwards, the value of those savings will depreciate and be worth less in the future.
“There is a danger that individuals and companies will not want to spend money and could withdraw cash deposits and keep it under their mattresses. This could be harmful to banks’ liquidity.
“Investors may seek non-UK deposit takers in order to seek out positive interest rates. These accounts could be held directly but could also be positive for offshore bond providers who can allow access to multiple deposit takers under a single tax wrapper.
“As company earnings and the dividends they pay will become more valuable to those seeking an income or a positive return, the price could be driven up, having a positive impact on stock markets.
“As a negative rate would have an impact on gilt yields, we would also see this impact pensions. Annuities are largely priced based on gilt yields and so we could see a dip in annuity rates. Large pension schemes will also have to be careful as many use gilts and a way of hedging against stock market volatility.
“This could be disastrous for final salary pension schemes as companies may not be able to afford to make the contributions necessary to secure the income for the scheme members.”
Short- or long-term problem?
The Financial Conduct Authority (FCA) has reportedly issued a survey for advisers on how prepared they are for negative rates.
Does this mean the regulator believes dipping into negative territory could pose a long-term problem for the advice sector?
Quilter’s Owen said: “This is hard to know; we are in very uncertain times. If we look to other countries, Japan went into negative interest rates in Jan 2016 and is still in negative territory so it could be a long road ahead.
“However, recent positive news may change sentiment and the outlook for the future meaning that we avoid negative interest rates altogether.”
Lewis Bronwlee’s Burns added: “Just because the Bank of England base rate goes negative doesn’t mean that rates charged to clients will follow. From a technical perspective, the base rate can only influence one part of the yield curve, with the market and sometimes bank buying bonds settling the rest.
“If the stock market is enthusiastic about the policy reflating the economy yields could rise at the longer end of the curve – having the opposite effect in some places.”