The Bank of England (BoE) have recently asked banks to provide details on how they would cope with negative interest rates, but how would you cope?
The BoE interest rates are currently set at 0.1%. These are historically low, however, the BoE are still exploring whether the mainstream banks are operationally ready for interest rates to go below zero.
This isn’t unknown territory as Japan, Denmark and Switzerland have all had periods of negative interest rates. The reason behind this approach is to try and boost the economy. By making interest rates negative, there is very little incentive for consumers to hoard cash. Instead, consumers are encouraged to disperse the money into the economy either via increased spending or investing.
The question is, will the mainstream banks actually start charging consumers for holding money in deposits? My honest answer is, I don’t know. I feel like it’s unlikely, but it would only take a couple of banks making a brave decision and everyone could follow suit.
I would also argue, perhaps controversially; does it matter? The really important difference is the gap between interest rates and your personal rate of inflation. With inflation so low (RPI is currently 0.5%: ONS Aug 2020) it may not matter if interest rates go negative in the short term.
For our financial plans, we tend to assume that inflation is an average of 1.5% higher than cash interest rates over the long-term. So the real danger will be if interest rates stay negative for a while, whilst inflation increases.
So if it doesn’t matter in the short term, what should you do? The answer is, it depends on your particular financial plan, but below are some general tips for what you should hold in cash…
- Don’t hold excessive amounts in cash, as it can act as a drag on your financial plan.
- Make sure you hold an emergency fund in cash for unexpected spending needs.
- Any big spends in the next 5 years? Hold these amounts in cash.
- Any cash you are holding, look at securing fixed rates asap.
If you would like a chat about how negative interest rates might affect you and how cash should fit into your financial plan, please do get in contact.