How would negative interest rates affect savings?

    14 October 2020

    I remember as child clutching my Post Office savings account book thinking how kind it was of the lady behind the till to add a bit extra to my savings every time I called. In fact, I still have the book. It records that on 20 September 1974, a week after my 8th birthday, I deposited £3 to add to my £30.79 – and found the account being topped up with £1.14 interest into the bargain. Big money. I allowed it accumulate for a decade until I blew all but £20 of my then £370 savings on a month-long Inter-Rail trip.

    That is not an experience which today’s children are going to be having in the near-future – neither the Inter-Rail trip nor the addition of interest to their savings accounts. This week the Bank of England wrote to retail banks asking them if they were prepared for negative interest rates. We’ve become used to derisory interest over the past decade. You would be lucky to earn £1.14 on a nest-egg of £1000 now. But could we really reach a stage when instead of being rewarded with interest, the bank presented you with a bill for looking after your money?

    The feeling is probably not, at least not for modest savers. The Bank of England’s target is more the banks themselves – it is trying to persuade them to lend rather than sit on their money. For a savings bank to charge small savers for looking after their money would almost certainly lead to a run on deposits – and a boom in mattress sales as savers converted to cash. Interestingly, the value of bank notes in circulation surged during the last banking crisis, presumably as people ceased to trust the institutions.  So much for the ‘cashless society’ – low and negative interest rates are making cash look much attractive than ever. Indeed, the fear that people would withdraw money if offered negative rates is one of the reasons why some central bankers have been so keen to push for a cashless economy.

    But larger savers? Banks might well try their luck and pass on negative interest rates to them. But again, they will risk the mass exodus of deposits – not so much to disappear under the mattress as to be reinvested in property and other physical assets. Having never had negative interest rates we cannot know, but my guess is that savers would show a very different mentality to negative actual rates of interest than they have done to negative real rates of interest. Let’s face it, with inflation bouncing around two per cent for years and savings rates of one per cent or less, we have been paying banks to look after our money for years. But still it will take a very big mental jump to accept it if our actual balance reduces over time.

    One thing is for sure, negative interest rates are not going to help to promote the idea of saving – something which Britons (or at least those who have managed to keep their jobs) have rediscovered during the Covid pandemic. Nor are they going to maintain a good choice of savings accounts on the market. It may kill off the remaining building societies, given that they would have to pay the Bank of England for depositing their own money.

    Homebuyers with mortgages can pretty well forget about the prospect of being paid to borrow money – that is highly unlikely to happen. But with many unhappy savers looking for somewhere else to store their savings, negative interest rates could provide yet one more boost to the housing market. I’m not sure that is what the bank of England has in mind, but so deeply are British investors attracted to bricks and mortar it is hard not to see it happening.