Paying for bank accounts: how negative interest rates will cost you

How low can interest rates go? Base rates in Switzerland and Denmark are negative. Several countries are seeing their debt trading on negative yields (see this column from last week on what this means). And there is increasing conjecture that this is just the beginning.

The UK base rate is a mere 0.5% (one quarter of its previous record low). The assumption is that it will rise from here as the recovery consolidates. That isn’t a given.

Today, the Bank of England’s Monetary Policy Committee (MPC) held it at 0.5%. But the pound is strengthening (thanks largely to eurozone QE announcements); wage growth isn’t yet looking like much of a problem from an inflation point of view; and inflation all in is near zero.

In normal times that would suggest a rate cut rather than a rate rise was on the way. So it isn’t, as Aegeon put it “inconceivable that we see the dovish members of the MPC start to consider a 0.25% rate as an option”.

But why stop there?

This week, Gavyn Davis of Fulcrum Research put out a note called “How negative can interest rates go?” The question itself seems absurd – the very idea that anyone should have to pay someone to keep their money safe rather than demand an interest payment for the use of their money is counter-intuitive. However it’s an idea we have to get used to.

Davis’s answer to his own question is that rates can go very low. Economists have always assumed that the lower bound for interest rates is around zero. That’s because we have the option to just hold physical cash ourselves (on which the interest rate is obviously zero).

But this is an assumption that is being tested by today’s extreme monetary policy – and so far being found to be dodgy: already central banks in some countries have “forced short term interest rates deep into negative territory.”

It may be the case that if governments push the negative interest rates thing too far “the entire economy would become a cash based system”. But that might take a while to get to.

Cash is “inconvenient to hold and use for large transactions”. It can also be “lost or stolen”. So most honest citizens would probably be “willing to hold bank deposits even if they are charged to do so.”

The key question is just much they are prepared to be charged – just how valuable is the security and convenience of holding money on deposit considered to be by the general population? The more valuable it is, the more negative rates can go.

We don’t yet know any of these answers, but the ideas are now being “seriously tested”. Interesting times.

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