Investments  

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
CPD
Approx.30min

Either of those outcomes has a short-term positive impact for the government.

For example, in recent weeks, UK government debt with two years until it falls due has traded at a negative yield.

If investors shun that debt and buy bonds that are not due to be repaid for ten years, then the government can be certain of what its interest costs will be for a longer period of time, and do not have to worry about trying to refinance the debt in two years.

If the economy were still struggling two years from now, it may be the government would have to offer a higher interest rate.   

Those investors put off by the negative yield but also unwilling to commit their capital for ten years may decide to invest in corporate bonds with a short date to maturity.

This boosts the government because if those companies are able to borrow cheap now, they are more likely to be able to survive the recession and keep staff in their jobs. This means the amount of cash the government needs to raise to pay for things like unemployment benefits falls. 

David Page, head of Macro Research at Axa, says he believes that interest rate cuts may be less effective at the low level they have traditionally been. 

He says: “If you cut rates from 5 per cent to 4.5 per cent, that would tend to have a major impact on the wider economy, but I am not sure that cutting from 0.10 per cent to a negative number will make that much difference.” 

Seamus Mac Gorain, head of global rates at JP Morgan Asset Management, says that while the rate cuts are likely to be small in practical terms, “people will go a long way to avoid buying an asset with a negative yield”, so the impact could be significant. 

Commercial banks

Among the largest holders of government bonds are commercial banks, which are required to hold cash or short-dated low risk bonds by regulators, meaning they effectively have no choice but to own bonds with a negative yield. 

But in addition to the bonds they are required to hold, banks may, in recessions decide to horde more cash than that, rather than lend it out into a risky economy.   

If bonds have a negative yield, then, the theory goes, even in a recession, banks would rather lend the money out than horde it, boosting the level of activity in the economy and so stimulating growth. 

Simon Edelsten runs the £296m Mid Wynd investment trust and has been investing in Japan and Eurozone equities for many years. He says bank lending has not increased materially since negative interest rates were introduced. 

CPD
Approx.30min

Questions appear on the last page of this article.