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Could the UK see negative interest rates? What does this mean for you?
Recently, there has been a lot of speculation around the Bank of England hinting towards the possibility of introducing negative interest rates next year if the UK economy continues to struggle.
If negative interest rates were to be introduced, this would be the first time in history the UK would have introduced this kind of monetary policy.
The Bank of England’s Monetary Policy Committee, the MPC, have currently decided to maintain the headline interest rate of 0.1%, which is still the lowest rate in the banks 325 year history.
You can view the Bank of England’s Monetary Policy Report and Financial Stability Report – August 2020 here.
The Bank of England’s governor Andrew Bailey, has previously said that negative interest rates were, “in the box of tools”, which has created a frenzy of speculation that indeed, negative interest rates could be on the cards in the not so distant future.
So, if interest rates are already at 0.1%, that doesn’t leave any more room to reduce interest rates any further. Therefore, are negative interest rates inevitable in the current economic climate?
What are negative interest rates?
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In simple terms, negative interest rates are any interest rates below 0.
Negative interest rates are a relatively recent and controversial monetary policy which aims to stimulate economic growth.
Some European countries started to introduce this unorthodox monetary policy following the 2008 financial crisis.
High Street Banks, for example, would essentially have to pay the Bank of England (or any central bank) if they store cash at a central account. This policy aims to encourage high street banks to lend more money to people and business, therefore stimulating the economy.
Good news for borrowers.
In this scenario, borrowing money would be cheaper, so good news for anyone taking out a business loan, mortgage or maybe re-financing existing debt, as money would essentially be cheap to borrow.
Bad news for savers.
If the UK does decide to introduce negative interest rates, then this is particularly bad news for savers who put their money in a standard bank account. It would be unlikely that they would see any interest on their savings whatsoever. In some cases, people who have deposited money in a bank account would actually have to pay the bank for the privilege of holding their hard earned money.
TSB, for example, have already announced that they will no longer pay any interest on its ‘Classic Plus’ current account from December. Therefore, the interest rate will be 0%. (Source: moneysavingexpert.com)
This is particularly ironic because of the fact that, when you deposit your money into a bank account, the bank then takes ownership of that money and is contracted to only pay you back that money when you ask them to.
Therefore, if you were to deposit cash into your bank account, that cash would become the property of the bank and they credit your account for said amount. Your deposit shows up as credit in your account not asset.
The moment you deposit your money into a standard bank account, it is now part of the fractional reserve banking system and the bank essentially owns that money to use however it pleases. Because the bank now owes you that money, this can introduce all sorts of counterparty risk.
In a negative interest rate scenario, in theory, you would be paying the bank, who would then use your money to make them more money.
Critics of negative interest rates.
Not only does negative interest rates harm the average saver, many critics of the negative interest policy argue that this type of policy would cause even more distortion in the financial sector, creating huge asset bubbles, especially in the property and equity markets which many argue are already overvalued.
Real vs nominal interest rates.
The interest rate most people are familiar with is the nominal interest rate. This is basically the amount of money you would earn in a year on your savings of say £1000.
The real interest rate would measure how much that same amount (£1000) is worth in terms of what you can buy with it a year later.
If you were to buy some apples today and they cost £1, a year later those same apples may cost you £1.03p due to 3% inflation. If your bank pays you a nominal interest rate of 0% then your real interest rate is negative 3%, as essentially you have lost 3% of your purchasing power.
Inflation in this scenario actually amounts to a negative real interest rate.
On the other hand, if we are in deflation of say 3% and your bank still pays you a nominal interest rate of 0%, then your real interest rate is positive 3% even though you haven’t received any interest on your savings.
Your savings depend on the nominal interest rate, but also inflation or deflation.
Could gold help you?
Gold and interest rates traditionally have a negative correlation, with gold prices usually going up as interest rates go down.
There has been a long standing argument that gold doesn’t produce any interest.
However, with negative interest rates, your money would now be costing you money if you leave it in the bank. In this sense, it would potentially make more sense to move your money into precious metals, specifically gold, which has been a strong and reliable store of wealth for thousands of years.
A main concern with negative interest rates is, at which point do the general public, financial institutions and corporations, suddenly want to sell all their bonds and bank deposits and demand cash instead?
This would then cause major problems for the core functioning of the whole financial system.
There is now a possibility that we are heading towards the end game for the fiat currency system, as negative interest rates is a relatively new monetary policy which is not fully tried and tested. We are in truly financial unchartered territory.
Gold can be used as a hedge against the systemic risk of financial markets crashing. Think of the 2008 financial crisis, major stock market crashes or even countries defaulting on their debt (Greece?). When a market crashes, everything gets sold except for ‘flight to safety’, or ‘safe haven’ investments, such as gold.
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