Negative interest rates


In late 2020 the prospect of negative interest rates made headlines.

I had several clients ask me whether their bank would start deducting, rather than adding, interest to their savings. This seemed unlikely albeit not impossible and business deposits would probably be the first place to start being charged for holding cash.

With inflation rising and now 2.5%, increases in interest rates should naturally follow, but with the Bank of England expecting inflation to fall back at the end of the year, and significant personal, corporate and government debts to think about as well, I doubt interest rates will increase any time soon. And even if interest rates do increase, I think they will be increased very, very slowly.

Traditionally thought of as a last resort, negative interest rates have been adopted by the European Central Bank and Bank of Japan and central banks in Denmark, Sweden and Switzerland have also had borrowing costs below zero at various times in the last five years.

Andrew Bailey, governor of The Bank of England has said these policies have had “mixed reviews” and some critics have noted that they lower banks’ profitability, thus reducing the likelihood of them lending, exactly the opposite of what reducing interest rates should do!

Long gone are the pre-2008 days of getting a 5% return on your cash savings.

With returns on cash being near non-existent for the foreseeable future, this is pushing people into riskier assets in search of a return.

But cash is not the only source of possible negative interest. The next lowest risk asset after cash is government bonds… and this is where it starts to get complicated! Negative yields on government bonds affect the investors who own them (frequently pension funds and insurance companies, but also ordinary investors as well) as they are paying to lend money to the issuing government if they hold the bonds to maturity.

However, negative yields don’t necessarily mean negative returns; in 2019 German government bonds had a negative yield but returned 6% as their capital value increased.

Despite the meagre returns, cash does have a place in everyone’s financial planning; if you’re saving for a house deposit, you need the certainty of cash and avoid anything equity based that could fall 15-20%; if you have a big ticket spend coming, such as a family wedding, a new car or starting a business, you need the certainty of cash for the same reasons; and everyone needs a few months of spending to one side in cash just in case.

Beyond situations where you need the certainty cash provides, you need to take some risk and invest a proportion in the equity markets. Whether you have 40% in equities and 60% in bonds, half in each, or any other combination is entirely down your risk appetite, what you are comfortable with and what you want the money to do for you. You don’t have to go all guns blazing in a 100% equity portfolio.

But if you’re committing money for anything over five years away, notably your retirement and later years, despite the threat of negative interest rates and the outlook for the economic recovery, a balanced and well diversified global portfolio has historically always been the best way of achieving financial security.