The current economic climate has led to falling interest rates around the world and even to negative interest rates in some countries. Negative rates could effectively mean that savers have to pay rather than earn interest on their savings. Some countries have already started to use negative interest rates, including the European Central Bank and the central banks of Japan, Sweden, Switzerland and Denmark, meaning that retail banks have to pay to safely store excess cash at the central bank.

The rundown
  • Negative interest rates are sometimes used to boost the economy after a crash or recession
  • Negative interest rates mean low interest rates on savings
  • The effect that negative interest rates have on a country’s economy can vary

What are negative interest rates and
how do they work?

Negative interest rates mean that financial institutions may have to pay interest to borrowers instead of earning interest from them, but savers could also be affected. Unfortunately, negative interest rates aren’t a new phenomenon. Although this practice may be unfamiliar to the British public, countries around the world have already experienced negative interest rates. For example, the base rate is currently -0.6% (February 2021) in Denmark [1].

When the national base rate drops to a negative figure, banks face the decision of whether or not to pass this cost on to their savers.

Which countries have negative interest rates?

Following the global financial crisis of 2008, interest rates were cut around the world. The European Central Bank (ECB), the US Federal Reserve, the Bank of England and the Bank of Japan cut interest rates to almost zero, and in June 2014 the ECB cut its rate to -0.10%. Switzerland, Sweden, Hungary and Japan have since followed suit.

In some European countries such as Germany and The Netherlands, banks are passing on the ECB’s negative interest rates to their corporate and retail customers. 

Over the last few years, banks all over the world have started using negative interest rates, as seen below [2].

Why are negative interest rates being used?

Negative interest rates are an unconventional way of trying to stimulate economic growth by making it cheaper to borrow and therefore boosting spending and investment. If successful, negative rates could help prevent a global recession while easing the burden of debt that many economies are under.

What are the economic effects of
negative interest rates?

Negative interest rates can affect the economy in the following ways:

  • Low-interest traditional savings accounts mean that savers might instead invest in the stock market to try and get a better return on their deposit, which pushes stock markets up.
  • In turn, this can then lead to a stock market crash.
  • If there’s a recession, central banks don’t have many options left to try and stimulate the economy as there’s little scope to reduce rates further.

What are the effects of negative rates?

Negative interest rates can affect the economy in the following ways:

  • Low-interest traditional savings accounts mean that savers might instead invest in the stock market to try and get a better return on their deposit, which pushes stock markets up.
  • In turn, this can then lead to a stock market crash.
  • If there’s a recession, central banks don’t have many options left to try and stimulate the economy as there’s little scope to reduce rates further.

There’s a common argument as to how negative interest rates affect lenders specifically. During times of high interest rates, cash flow usually increases, as shown in the chart below. This is because consumers take advantage of better returns, knowing they’ll earn more interest. Therefore, a counter argument against using negative interest rates to boost the economy is that they could have the opposite effect. 

What are the effects of negative rates on consumers?

In theory, negative interest rates mean that savers won’t earn as much interest on their deposits as they once would, but some banks have helped to ease this burden. In countries with negative interest rates, although banks may pass their costs on to savers who hold deposits with them, to date, few banks have done so.

Who benefits from negative interest rates?

Negative interest rates are arguably seen as a tool against unprecedented economic turmoil, used to boost the economy and create a surge of borrowing by facilitating low rates on lending. The theoretical aim of negative interest rates is to benefit everyone by improving the economy.

Will negative interest rates happen in the UK?

In the short term, introducing negative interest rates in the UK is highly unlikely, as the Bank of England isn’t sure our banking systems are prepared for it. In late 2020, the Bank of England began engaging with banks and financial institutions on operational considerations regarding the feasibility of negative interest rates. 

As of February 2021, that work is still in progress and may be for some time. Once the Bank is satisfied that negative rates are feasible, introducing negative interest rates will be decided by their Monetary Policy Committee (MPC), which will determine whether they are the optimal tool to use in the UK at that time.

What might this mean for your UK savings?

Although the base interest rate in the UK is not negative, it has been on a downward trend over the last few years and was cut to 0.1% in March 2020. Interest rates on certain savings accounts such as ISAs are low, so you may be wondering where to look for competitive interest rates.

This is the view from Raisin UK’s co-founder and savings expert, Kevin Mountford:

“Talk of negative interest rates has been around for some time now, and recently the Monetary Policy Committee (MPC) asked banks to use the next six months to prepare for such an event. While it’s right to consider negative interest rates as part of the monetary policy tool kit, it’s still far from a done deal. The UK has never operated in a negative interest environment and there are still a number of challenges to overcome, ranging from bank system capability, UK consumer attitudes and, of course, whether it will have the desired effect. 

That effect is that negative rates would provide cheaper borrowing and act as a disincentive for savers, which would get us to spend some of the cash we have been squirrelling away during the pandemic. In reality, the competitive nature of the UK market means that it’s highly unlikely UK retail savers will have to pay banks for the privilege of looking after our money. We only have to look to continental Europe and the likes of Germany to see that negative savings rates have only really hit higher value corporate deposits. 

In summary, it’s important to continue to save and seek out the best value products, and not be alarmed into thinking you’ll need to keep cash under the mattress.”

You can guarantee a risk-free return on your deposit by opening savings accounts with a fixed interest rate, such as fixed rate bonds. If you have a lump sum you’d like to invest and can afford to lock your money in for a set period of time; you’re more likely to earn a competitive interest rate. 

At Raisin UK, we have partnered with banks offering deposit-protected savings accounts that beat interest rates’ downward trend. 

How to open a savings account at Raisin UK

To open savings accounts from our partner banks, you first need to open a Raisin UK Account; then you can apply in just three steps:

  • Log in to your Raisin UK Account
  • Click to apply for a savings account
  • Transfer your deposit

Once your application is approved, simply deposit your savings and start earning money straight away.

If you’ve got any questions, please contact our UK-based Customer Services Team, who will be happy to help.

Sources:

1. https://www.nationalbanken.dk/en/marketinfo/official_interestrates/Pages/Default.aspx

2. Reproduced from https://itfa.org/the-upside-down-world-of-negative-interest-rates-by-giovanni-bartolotta-cro-at-aps-bank-plc-jan-2020/

 

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