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What will negative interest rates mean for investors?

25 November 2020

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 (BoE) 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.”

Client panic?

Given it is not something they have faced before, negative interest rates could inevitably spark some 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?

Hannah Owen, at Quilter Private Client Advisers, stated: “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.”

Knee-jerk reactions

First and foremost clients should settle their nerves and not apply knee-jerk reactions or taking on unnecessary risks after being inundated with scary headlines.

Keeping a close eye on what happens to mortgages could be helpful as negative interest rates may 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.

If however you are holding a good amount of cash you should consider the opportunity to discuss 'cash risk' with an advisor as cash is losing value in real terms due to inflation.

It is always important to ensure holding an appropriate emergency fund of cash but not excessive amounts.

Once an emergency fund is built up, it may be better to invest cash particularly if there are negative interest rates.


Impact on pensions and investments

Negative interest rates will undoubtedly have an impact on mortgages but it could also negatively influence the pensions and investments market.

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.

A Canada Life spokesperson commented “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 a 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 holders who can access 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.”

If you feel the need to discuss any of the above issues please contact us