Are negative interest rates likely?

This time last year I couldn’t have imagined writing an article on the subject of negative interest rates.

Low interest rates, yes, but negative? Certainly not!

2020 has been a year of many ‘firsts’ for all of us as a result of the Coronavirus pandemic, so the concept of negative interest rates, unfortunately, continues the theme.

At present, government bond yields and bank deposit rates sit very substantially – and uncomfortably – below where they were 5 and 10 years ago, in negative after-inflation terms and more-or-less-zero before inflation terms.

In March this year, the UK Government issued its first negative-yielding gilt borrowing £3.8 billion at -0.003% for a 3-year maturity. Strange as it may seem, this means they are getting paid to borrow money by investors!

The Bank of England amongst other central banks has hinted that negative interest rates remain an option if needed to help the economy. Denmark has already seen home loan offers at a negative interest rate, meaning that mortgage borrowers pay back less than they borrow. Whilst seen as a useful stimulant in helping firms and consumers to have the confidence to borrow the problem remains that if commercial banks are charged for placing deposits with the Bank of England then they are likely to pass these costs onto retail depositors.

In effect, negative interest rates represent a transfer from savers to borrowers. However, there would appear to be limitations to negative rates as banks and individuals might well decide to hold bank notes instead at no cost if negative interest rates persist.

A number of solutions have been put forward, including the potential to run a system of dual interest rates targeted at one rate for bank lending (e.g. -1%) and one for bank deposits (e.g. +0.5%). The aim would be for borrowers’ net income to rise and cause greater economic stimulus through lending to companies to invest in projects.

The one thing that is certain is that it will be extremely hard to preserve the purchasing power of cash in the coming months and possibly years.

Having enough cash to meet emergency liquidity needs is important, but it will be imperative to make sure that any longer longer-term assets are sensibly invested.