What negative interest rates could mean for your clients

  • Describe the bank of England's stance on negative interest rates
  • Explain some of the intended consequences of negative interest rates
  • Describe some of the negative consequences of negative interest rates
What negative interest rates could mean for your clients

If two decades ago, you had told investors that most European economies would be operating with negative interest rates and that bond investors would be paying money to lend to governments via negative yields, the investors' reaction might have been to question your sanity.

Furthermore, if a year ago, most UK most investors had been told that a Boris Johnson-government would be paying the wages of millions of workers, and subsidising the incomes of millions of self-employed people, that would have seemed beyond the realms of reason.   

But as the UK emerges bleary eyed from months of lockdown and see the contours of an economy wrecked by reduced demand, everyone is wracked with uncertainty about what will happen when the government support scheme ends.

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Former Bank of England governor Mark Carney, speaking in a world before Covid-19, said negative interest rates were not a policy he would want to pursue in the UK due to a general scepticism about whether the policy works over the long-term,

There was a particular concern about the effectiveness of negative interest rates on the UK economy, as it has substantial exposure to financial services companies, which would be particularly badly hit. 

Negative interest rates might be needed

But Mr Carney’s successor as Bank of England governor, Andrew Bailey, has said, negative interest rates may now be needed in the UK as part of the response to the pandemic.

Speaking before a recent meeting of the Treasury Select Committee of the UK parliament Mr Bailey said that he would “not rule out as a matter of principle” the introduction of negative interest rates in the UK. 

He said the bank is “keeping interest rates under constant review and seeing how the economy is responding to the rate cuts we have made so far before deciding on further steps.” 

Negative interest rates presently exist in the Eurozone, Switzerland, Japan and some Nordic countries.

In Switzerland and the Nordics, negative interest rates are there to prevent the currency from becoming too strong, while in Japan and the Eurozone the motivation is to try to generate economic growth and inflation by increasing the supply of money in the economy. 

Increasing the money supply happens when commercial banks lend it into the wider economy, because they only have to keep a small portion of the capital they have at hand.

If this cash is lent out to consumers and businesses, that should spark economic growth due to the extra spending, and this would be inflationary. 

Michael Michaelides, fixed income strategist at Carmignac, says that in a steep recession, and at a time when governments are borrowing money, negative interest rates could play a broader short-term role than just enabling new consumption to happen.

He says most bond investors would be eager to avoid investing in negatively yielding assets, and so will either switch out of short-dated government debt with a negative yield, or if they want to continue to own short-dated bonds, then will switch to bonds issued by companies, rather than countries.