Negative interest rates – who really gets bitten

As the FT has reported last week: “Growing expectations for further rate cuts in the UK sent yields on government bonds below zero on Thursday, with debt prices fired up after Bank of England governor Andrew Bailey indicated that negative rates were “under active review”. The yield on the five-year gilt fell below zero for the first time, meaning buyers were willing to accept a nominal loss if they held the debt to maturity. Yields sank as far as minus 0.012 per cent, according to Reuters. Two-year yields hit a new intraday low of minus 0.062 per cent.”

The Bank’s base rate stands at 0.1%, the lowest level on record, so it would not take much to take it into negative territory.

At the moment, high street savers should not worry. Those affected are generally speaking the very wealthy, pension funds, life assurance funds and so on. For the wealthy, the £85,000 government bank deposit guarantee scheme is completely meaningless. For others with large scale funds such as pension managers, they know that governments with their own central banks that have the luxury of their own currencies that the probability of going bust is next to nil. Having an efficient tax system that rakes in hundreds of billions a year and a history of always paying back its debt provides further assurance.

To give some perspective – in 1945, Britain’s finances were, to coin a phrase – shot to bits – after a second round of world war. Its debt to GDP (the national debt) was very nearly 250 per cent. Today, it is shockingly high for such a rich nation at 86 per cent. So there is plenty of room for another half to one trillion of national debt.

The Bank of England has for the first time applied negative interest rates to its bonds and for those that hold vast amounts of cash, it is merely an expression of investor fear that asset prices will fall – hence that over the next three years, these ‘investors’ are prepared to pay a rate to protect their cash from the oncoming storm.

Will savers get clobbered one day? It’s possible, but not likely for the foreseeable future. In Europe, its central bank (ECB) offers minus 0.50 per cent. In August last year, Denmark actually started offering negative mortgage rates – meaning they paid you to take out a mortgage. This was because it was costing them to have money in the central bank in the first place. The reason for negative rates is to force money out into the economy and it is not beyond the realms of rational thinking that negative savings rates could be applied if the economy sinks further than expected or does not rebound quickly enough – which I suspect it will not.

Mortgages will get a little cheaper but the expectation is that the housing market will, first of all, seize up, then property prices will start a gentle decline for at least until the end of 2021. The money markets have bet on falls of about 12 per cent by this year-end.

For further evidence of an economy going into a tailspin – the IHS Markit Purchasing Managers’ Index (PMI) hit a record low in April, and a large majority of companies reported that activity continued to fall in May, albeit on a less widespread basis than just after the lockdown began. The not so bad news is that there are signs the economic spiral may be slowing and showing some signs of resilience.

Chris Williamson, IHS Markit’s chief business economist, predicted more businesses would report a pick-up in June as the COVID-19 lockdown is relaxed. “However, the UK looks set to see a frustratingly slow recovery, given the likely slower pace of opening up the economy relative to other countries which have seen fewer COVID-19 cases,” he said.

That said, the expectation is that the unemployment rate by the back end of this year is likely to be something in the order of 3 million or thereabouts. Not only would that be a disaster for hard-working people and their families, but it will also put further strain on the treasury going forward. The truly awful Universal Credit system will then be berated, ridiculed and shredded once another couple of million get registered and find that ‘computer says no.’ That won’t wash with people who normally work to support themselves or their families.

 

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