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The Nasty Virus of Negative Interest Rates

29 Jul 2016

Justin Urquhart Stewart, Head of Corporate Development

Two high street banks have warned that business customers may have to pay for the bank to keep their money on deposit, but will they stop there? We look at what the current level of interest rates means for savers and ask if there are other options available.

The Nasty Virus of Negative Interest Rates

It has been like watching a virus spread or a creeping infestation, and now it has finally reached our shores in the UK. No…it is not the bubonic plague…nor are we being overrun by cockroaches, but rather the ruinous, financial illogicality that are ‘negative interest rates’.

 

It is almost counter intuitive to have to explain to someone that they will have to pay for the privilege of keeping their money on deposit with a bank, but that is what NatWest and RBS have now warned some 1.3 million of their business and corporate clients could happen. Of course, they will not be described as negative interest rates, but far more politely and ‘acceptably’ described as a modest charge for maintaining cash deposits. It is still the same thing though. I suspect that some of these old banks probably couldn't even get their creaking mainframes to be able to calculate a minus interest rate anyway.

 

As yet no one is suggesting that this extends to private customers, but it is not impossible. The reality though is that many of us are already suffering negative interest rates given the derisory returns we currently get on most deposit accounts—rates that hardly even cover the existing low levels of inflation. With the outlook for higher inflation coming through potentially later in the year, then many more of us will be in the same position. Welcome to the strange world of negative earnings! 

With cash rates unlikely to change by much, many are going to have to consider if they can tie up some of their funds over longer periods of three to five years and take a somewhat higher risk to try and earn a better return.

 

Of course, it is the hard pressed savers who over the years have obeyed the financial rules and paid down their debts in good order, put aside cash carefully over time, and instead of being rewarded are now suffering for their sound actions. If, however, you were a profligate borrower, the cost of your spending has never been lower. Given that there are far more savers than borrowers, this does seem to be very unfair on this (often older) group who have little alternative to significantly change their position.

 

With cash rates unlikely to change by much, many are going to have to consider if they can tie up some of their funds over longer periods of three to five years and take a somewhat higher risk to try and earn a better return in the investment market. Over the past 10 years, a reasonably balanced portfolio of assets around the globe could have earned you an annualised return of just over 5% every year after all the costs (which would have been even better if it were in an ISA wrapper). Not bad considering all the banking and financial gyrations that we have seen over the past decade. So a little more risk may well be acceptable in exchange for some patience over a slightly longer period to be able to enjoy a promotion in one's savings.

Of course, low rates should encourage more borrowing and thus hopefully greater expenditure by consumers and investment by companies. However, if low rates are accompanied by a lack of confidence, then it is likely to generate very little effect. At times of such private sector nerves, it will be down to the state to step in and try to bridge this period of concern until the private ‘mojo’ is restored. We have already heard hints that the budgetary collar of the Osborne-days is likely to be loosened, and maybe, therefore, we are about to see a bout of good, old fashioned Keynesian economics of state investment into infrastructure and our desperate housing shortage. Mrs. May has already fed us new lines: no longer is it speeches of austerity; rather the language of ‘living within our means’. That does not necessarily mean no borrowing, but rather borrowing over the longer term at record low-level costs to support investment in the UK. That is still within our means in my book.

So it is going to be interesting to see how these negative rates play out, but what is clear is that cheaper or even ‘free’ money (often nicknamed helicopter money) in itself does not increase demand and expenditure. I would like to see this as a time to reward some of our savers with access to infrastructure and investment bonds issued by the Government that yields a better return than ‘minus’, whilst at the same time directing investment into vital future products, services and facilities for the UK.

Boohoo for Yahoo

You can start to feel your age when the dynamic and exciting brand names that grew up with you finally start to fade into obscurity. Last week saw the almost final demise of Yahoo as its core business was sold off to Verizon. From a standing start to a value of $125bn and then to be finally sold as a runt for $4.8bn is a sad tale of missed opportunities and poor management. However, I was reminded of a list of others that should prove to be a useful recap that this year's fashion fad can easily become next year's tank top. Take these for example: AOL from $226bn to being sold for just $4.4bn; AltaVista that was bought by Yahoo as part of a $1.7bn deal and then shut down; Netscape Navigator—effectively the only rival to Microsoft’s Internet Explorer—which was bought by AOL for $4.2bn and again shut down. There are many others including Pets.com, Friends Reunited, MySpace and Napster and no doubt there will be more to come in the future.

Pride coming before a fall is always the fear especially when businesses are based on future concepts and opportunities rather than sound business logic, finance, product and service.

And finally…some of us appear to be getting longer! Seemingly, in 1914, it was the Americans and the Scandinavians that were the tallest people in the world. Now they have been overtaken by the Dutch who boast of having the tallest men and the Latvians who have the tallest women. It would appear that the Americans stopped growing in the early 1970s—although in fact I think they just got wider rather than higher! Apparently, Dutch men average 183 cm which is quite a gap from East Timorese men who stand at just 160 cm. I can personally attest that some from those from eastern Indonesian islands do seem to have a greater connection to a Hobbit rather than your average Homo sapiens.

The fastest rate of increase has been among Iranian men who are 16.5 cm higher than they were a century ago, whilst South Korean women have been elevated by 20 cm (and that does not include the ubiquitous stilettos).

The figures that I do find slightly perplexing are that the good folk of Sierra Leone, Rwanda and Uganda appear to be somewhat shorter than they were 40 years ago. Presumably one must get used to keeping your head down given the times of strife that those nations have endured—if only to make sure that you don't lose it and so get even shorter.

Have a good week.

Justin Urquhart Stewart
Co-Founder
Seven Investment Management

Justin Urquhart Stewart is one of the most recognisable and trusted market commentators on television, radio and in the press. Originally trained as a lawyer, he has observed the Investment industry for 30 years whilst in corporate banking and stockbroking, and has developed a unique understanding of the market’s roles and benefits for the private investor.

This article represents a personal and light-hearted view from 7IM, and is based on current financial news and events around the world.  Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision.

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The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.

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