The Bank of England has written to the CEOs of several firms to ask whether their company would be ready if the base rate were to fall to 0% or go into negative figures.
The Bank of England and the Prudential Regulation Authority (PRA) are confirmed to be actively looking into the operational considerations of a negative base rate, and whether banks and other financial firms would be able to work with it.
It also points out that this assessment isn’t an indication that the base rate will definitely change to 0% or go negative – it is one of many of the banks ‘tools’ which aim to keep inflation at 2%.
The letter, sent out on 12 October, has given the recipients until 12 November to respond, ahead of the Bank’s final Monetary Policy Committee (MPC) meeting of the year on 17 December.
At its last meeting on 17 September, the MPC voted unanimously to keep the rate at this level, saying the country’s economic outlook remains ‘unusually uncertain’ as the pandemic’s impact continues and Brexit negotiations go less smoothly than expected.
Here, Which? looks at the impact that coronavirus and Brexit could have on interest rates, and what that means for you.
Why the base rate matters
The Bank of England base rate influences how much banks and other lenders charge customers to borrow money, and the amount of interest they pay on savings.
A lower base rate generally means lower interest on savings, so your pot will grow a little more slowly. But mortgage and loan interest rates are likely to drop too, making it cheaper to borrow.
Higher base rates usually mean that savings interest grows faster, but mortgages and loans become more expensive.
The table below has the base rate and the average standard variable mortgage rate since October 2016, for comparison.
The Bank of England changes the rate to help keep inflation at around 2%, which is considered a sustainable level, raising and lowering it in line with current events. It kept the rate the same for years after the 2008 crash, but Brexit – and now coronavirus – have forced the Bank to make quick and dramatic changes.
- Find out more: Bank of England base rate and your mortgage
Will interest rates turn negative?
The Bank of England said in June it was considering introducing a negative interest rate to help boost the UK economy in the future. This was reaffirmed in its minutes from its last meeting on 17 September, and the letter sent out to some CEOs is the next step in its assessment.
Firms’ responses could therefore have an impact on whether or not these changes are introduced.
If a negative base rate were to be introduced, it would be the first time the rate had dropped below zero in the country’s history, and it would have wide-ranging effects. Potentially, it could even mean you’d have to pay your bank to hold onto your cash.
Savings rates, already in decline, have fallen steeply since the base rate was reduced to 0.1% in March. Negative interest rates could make high-returns savings accounts even harder to come by.
On the flipside, borrowing could become cheaper, which would be good news for people with mortgages.
- Find out more: Bank of England considers negative base rate
Coronavirus crashes interest rates to record low
The pandemic’s spread in March caused the Bank of England to make two major cuts to its base rate in rapid succession.
On 11 March it cut the rate from 0.75% to 0.25% – a record low at the time. Just eight days later, the Bank slashed it even further to 0.1%, where it remains today.
Decisions about the base rate are usually made during scheduled MPC meetings, like the one that took place before today’s announcement. But March’s two cuts were made at emergency meetings called in coronavirus’s wake. These were the first emergency MPC meetings since the 2008 financial crisis.
The MPC changes the base rate with the intention that this will help ‘sustain growth and employment’. However, coronavirus continues to hamper both.
Thousands of jobs have already been lost, and mass unemployment is expected when the furlough scheme ends in October.
The UK officially entered a recession in August, with Gross Domestic Product (GDP) plummeting to its lowest level on record.
This alone would be enough uncertainty for the Bank of England to deal with. But as the minutes of the latest MPC meeting note, Brexit is also a concern.
- Find out more: your rights if you’re at risk of redundancy
How Brexit influenced interest rates
The Bank’s two emergency cuts in March were unrelated to Brexit. At that time – and indeed right up until August – the MPC was working on the assumption of a smooth transition to a free trade deal with the EU in January 2021.
However, recent decisions by the UK government, including a controversial internal market bill that the government has admitted will break international law, have thrown this into question.
Exchanges between UK and EU negotiators have become heated in recent weeks, with Boris Johnson saying the country will leave without a trade deal if a free trade agreement isn’t reached by 15 October.
The MPC’s September minutes make reference to ‘recent Brexit developments’ weakening the pound and causing concerns in the market. But it doesn’t say it has dropped its assumption of a free trade deal, only that it will consider ‘economic issues relating to Brexit’ ahead of its November meeting.
Before the pandemic, Brexit did drive the Bank to change interest rates. Just after the referendum, in August 2016, the base rate fell from 0.5% to 0.25%. It was the first time the rate had changed since March 2009.
Since then, the rate was actually raised to 0.75%, where it stayed until March, although policymakers were still watching Brexit developments carefully.
With EU trade talks still underway, and more to come with other countries, Which? has set up the National Conversation on Trade to give people from all walks of life a say on what they want from the UK’s post-Brexit trade deals.
- Find out more: Which? gives consumers a say on the future of UK trade
This article was originally published on 17 September 2020 when the Bank of England announced it was holding the base rate at 0.1% until the next MPC meeting. It was last updated on 12 October 2020 with details of the Bank of England’s letter asking financial firms about their readiness for a potential negative base rate. Additional reporting by Danielle Richardson.