Should we feel positive about negative interest rates?

Should we feel positive about negative interest rates?

We live in strange times. That’s for sure. But would anything be stranger than the Bank Of England introducing negative interest rates for the first time in 326 years? This might sound as fantastical as the plot of a low budget sci-fi movie – think Sharknado meets Hot Tub Time Machine – but apparently it could be on the agenda if the economy struggles to bounce back from Covid-19.

Reducing interests rates to negative territory would be a very bold move. They’ve been set at an historic low of 0.1% for almost a year, but now it’s being widely reported that those controlling our economic levers may go further to stimulate economic activity. 

A cut in interest rates would have big implications for the housing market. After all, if commercial banks will be charged to deposit funds with the Bank Of England, then they’ll naturally look to do something else with their money. And this could persuade them to offer better deals on loans, investments and, most importantly for the housing market, mortgages.

What’s more, commercial banks could look to pass on extra charges to customers; therefore the act of saving, counter-intuitive though it might seem, could become an expensive exercise for ordinary people. If nest eggs are slowly shrinking, then people will be more likely to spend.

Great news for house prices?

The big hope is that negative interest rates would lead to very favourable mortgage terms. With savings devalued and the cost of borrowing significantly reduced, the great British public might be inclined to invest in bricks and mortar. After all, it would be a perfect opportunity to either upsize or get on the property ladder for the first time.

It’s easy to see why this could be great news for house prices. Low borrowing costs have traditionally supported the housing market by making it easier for potential buyers to secure a mortgage or borrow more. With experts already predicting that Rishi Sunak’s Mortgage Guarantee Scheme will increase property prices, imagine what might happen if negative interest rates were introduced?

The result would be more buyers chasing a limiting supply of homes. Negative interest rates could also devalue sterling, which would make British properties even more attractive to overseas investors. Property investors would therefore be as happy as Larry the Downing Street cat, who has also been piling on the pounds recently. 

Why it might pay to borrow

Negative interest rates might create the surreal situation where people can actually make money by borrowing. In other words, they would ultimately pay back less than they initially owed. Although this might seem crazy, this actually happened in 2019 across the North Sea in Denmark where one of the country’s biggest banks offered a 10-year mortgage with a fixed interest rate of -0.5%.

Is it so far-fetched that UK commercial banks could do the same? Maybe not if they calculate that house prices will keep rising. After all, even extremely generous mortgage terms could be seen as a sound investment (in the current climate) if they are secured on safe assets. 

Fool’s gold?

Although it’s fascinating to speculate, the truth is that nobody knows what the effect of negative interests would be. It’s quite possible that nothing in particular happens at all. For example, banks might simply react by increasing banking fees rather than penalising their customers for saving. 

It’s also possible that banks might confound expectations by not offering generous mortgages. And even if they did, extra fees could cancel out the small savings borrowers might make. What’s more, let’s not forget that those currently on fixed-rate mortgages would be unaffected anyway. 

As for those on tracker mortgages, they might see a drop in their repayments but it’s unlikely that they’d escape interest payments completely unless interest rates drop by a significant amount. This is obviously because trackers charge interest at a set percentage above the base rate; therefore interest rates would need to be set below -1% before borrowers would have debts slashed. 

A step into the unknown

It will be interesting to see how the government and the Bank Of England play their hand over the coming months. The chancellor has bought himself some time by extended furlough but it’s difficult to see this happening again; therefore new strategies must be found. 

Whether negative interest rates will be one of them is up in the air. However, it’s likely that other measures to stimulate the economy will be taken first. After all, negative interest rates could be seen as a sign of serious economic trouble – in which case, banks might actually become more cautious about who they lend to.

Furthermore, it might be overly optimistic to expect people to buy houses in uncertain times. If they’re worried about their employment status, they might decide to protect what money they have rather than embark on new spending sprees – even if saving doesn’t pay in the short-term. 

Consequently, the introduction of negative interest rates would be a gamble. It might create surge of sales, it might have little to no effect, or it might backfire horribly. Let’s just hope that the new governor of the Bank Of England has a time machine – preferably one that doubles up as a hot tub – if it’s the latter.  

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