Interest rates are low, low, low. In fact they’ve never been this low. The UK base rate, that’s the interest rate benchmark and the rate at which the Bank of England will lend money to other banks, has been 0.5% since March 2009. To put this in historical context, the Bank of England was founded in 1694 and it wasn’t until January 2009 base rates went below 2%. But could we be about to see rates set even lower than the current 0.5% mark?
In part, this has already happened. The ECB, European Central Bank, the European equivalent of the Bank of England, announced deposit interest rates of -0.1% in June and -0.2% in September last year. Whilst this doesn’t really impact European High Street banking, it does impact on the behaviour of banks overall.
Central banks are essentially the banks banks. They are who high street banks borrow from and where they place their deposits. How they set their rates impacts the behaviour of high street banks which eventually should trickle down to the consumer and the economy overall.
Why do central banks change interest rates?
Enter every economics students favourite theory, mainly because it’s the easiest theory to understand, the paradox of thrift. The paradox of thrift essentially says, contrary to what we are always told, saving is bad. Saving means consumers and businesses aren’t spending money. If they aren’t spending money, demand for goods and services will fall, resulting in falling production across industries and a slowing down of the economy generally. Therefore, borrowing should be encouraged and saving discouraged.
And, surprisingly, saving is a pretty big problem at the moment. Reduced confidence in the economic climate has encouraged the richest to squirrel away cash for a rainy day. In fact Oxfam have previously estimated there are trillions, yes, trillions, of pounds sitting idly in tax havens. This is money that could be used to generate a lot of growth if we could just encourage its lucky savers to spend it.
Reducing interest rates tackles this problem. Low and negative interest rates mean the returns on having money in the banks are far lower than the returns on spending it on investments, saving just doesn’t make economic sense. But also the costs of borrowing are lower. This gives consumers and businesses more cash to spend simply because mortgage and loan repayments are lower.
But what do the current negative interest rates really mean, and is it something that’s likely to spread from Europe to the UK?
Firstly, a negative rate means exactly that, if you have money in the bank, banks will deduct a percentage of its worth as interest, rather than paying it out. Whilst this might not be good news for savers, a central bank’s main concern is the economy overall, keeping growth gentle and sustained. If savers lose out, that is just an unfortunate consequence.
Are negative interest rates likely to happen in the UK?
At the moment, probably not. The UK economy, whilst not great, isn’t doing anywhere near as badly as our European counterparts. It’s smaller, more settled and with less variances by region. The ECB, however, is playing fine balancing act with the various widely different economies and politics of Europe, not to mention the issues with Greece.
The UK also has a greater reliance on it’s financial services sector and from a practical perspective, negative interest rates are a nightmare for them. Not only are their computer systems unable to cope with negative rates, financial institutions are not permitted to pay negative returns to investors. Ultimately, this weakens them and the economy by impacting negatively on their growth.
Perhaps most importantly though, is the PR aspect. With the current rock bottom perception of banking in the UK, if negative rates were introduced and allowed to filter down to current accounts, the perception of bankers funnelling off cash from the general public’s accounts would almost certainly result in all out anarchy.
It’s just a lot more trouble than it’s worth.
What do you think? Have your say in the comments section below.