The Bank of England has given lenders six months to prepare for negative interest rates. But it stressed that this doesn’t mean the cut is a certainty.
Last week, the Bank of England’s Monetary Policy Committee (MPC) voted unanimously to keep the base rate, which acts as a guideline for banks and lenders when they set their interest rates, at 0.1% – the same level it’s been since March 2020.
But it was the revelation that the rate may drop below zero later in the year that made headlines. MPC members have been exploring the option of setting a negative rate since at least October last year, and while the move is not yet confirmed, the six-month warning is another step towards it happening.
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.
A higher base rate usually means 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 2020 it was considering introducing a negative interest rate to help boost the UK economy in the future. In October, the Bank sent a letter to banks and building societies asking them how ready they would be for a zero or negative interest rate, reaffirming the possibility of such a move.
Now, the Bank of England has said high street lenders should be ready for negative interest rates in July, just in case they are needed. However, if the success of the vaccination program leads to an economic boom before then, it might keep rates above zero.
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 on to 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-return 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 2020 caused the Bank of England to make two major cuts to its base rate in rapid succession.
On 11 March 2020 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. But March 2020’s two cuts were made at emergency meetings called in coronavirus’ 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.
The UK officially entered a recession in August 2020, 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 recent MPC meetings 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 of England’s two emergency cuts in March were unrelated to Brexit, although speculation around exiting the European Union has had an impact on the base rate in the past.
The Bank of England slashed the interest rate in half – from 0.5% to 0.25% just after the referendum on EU membership in 2016, although it did eventually raise it above pre-referendum levels two years later.
The MPC tended to work on the assumption that a trade deal would be agreed between the EU and the UK before the end of the transition period in January 2021. While that may have appeared overly optimistic during fraught trade talks, eventually it proved correct.
Now that the transition period is over and a new trade deal has been agreed, Brexit might be a smaller influence on the MPC’s thinking. That said, the minutes of the committee’s February meeting note that some firms it has spoken to still cite Brexit as one of their top three concerns.
- Find out more: the trade deals being negotiated and how they’ll affect you
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 8 February 2021 after the Bank of England announced again that it would hold the rate. Additional reporting by Danielle Richardson.