The Bank of England cut interest rates to a record low of 0.1% on March 19 in the immediate aftermath of the coronavirus crisis. Nearly a year on from that move, is the Bank preparing to cut rates into negative territory?
What would negative interest rates mean for shares, bonds, cash, gold and property? We look at the potential implications for investors.
Equities
UK equities: UK income seekers were hit hard in 2020 as a number of big names, including Shell (RDSB) cut or suspended their dividends. But, the FTSE All-Share is still yielding around 4.5%, which is attractive in the context of low inflation, low cash rates and near-zero gilt yields. At the end of last year there was a big move into value shares, which often pay the highest dividends. Negative interest rates could strengthen the case for higher yielding shares even further.
Global equities: Reducing interest rates further unleashes more cheap money into the market, which tends to push up riskier asset classes such as shares. For example, sentiment in the US market is often driven by comments by the Federal Reserve, which said it is unlikely to raise interest rates until 2022. Could the GameStop saga also be a sign of investors getting carried away with "irrational exuberance"?
Emerging market equities: Many emerging countries are still struggling to contain the coronavirus outbreak and economic growth is likely to be much weaker as a result in 2021. But the trend of a weaker dollar, which favours commodity producing countries, means that the asset class has become more attractive. Emerging market bonds and equity income look even more appealing if UK interest rates are negative. For example, Chinese 10-year government bonds yield 10 times more than their UK counterparts.
Bonds
Negative yields on two and five-year UK Government bonds suggest that fixed-income markets are still braced for the possibility of negative rates.
As bond yields move in the opposite direction to bond prices, a further fall in interest rates below 0.1% will push bond prices higher and yields even lower. Bond funds were some of the best performers in the March sell-off as investors sought out safety. Bonds also smooth out market volatility, which cannot be ruled out as equity markets regain new highs.
But owning the security of UK gilts comes at a high cost to investors: 10-year gilts are currently priced at £142, which means if you buy them now and hold them until 2031, you will only get £100 back during which time you'd only get a yield of 0.36% a year.
Low or negative yielding gilts suit the UK Government because it has a massive spending programme to fund, with borrowing set to hit nearly £400 billion this year, following the coronavirus pandemic. The Bank of England has committed to buying these bonds through its QE programme and many pension portfolios have to contain gilts regardless of yields.
Corporate bonds generally have much higher yields than government bonds because the risk of default is much higher, especially in a recession, so negative interest rates should boost the case for these bonds.
Commodities
We have recently published a commodities outlook for 2021, showing that gold has dipped recently after a strong run in 2020.
The traditional argument against gold, is that it doesn't produce an income and its price is dictated by sentiment. But in an world where there's a shortage of yield and some assets actually cost you money to hold them, that case is harder to make.
Negative interest rates are likely to put pressure on sterling, which has recently had a strong run against the dollar. Exchange rates matter for UK investors in dollar-denominated commodities: when gold was last above $1,700 in 2012 and sterling was around $1.60 that ounce would have cost you just over £1,000. But now with the pound at $1.35 and with gold at $1,835, that ounce will cost you £1,345.
Cash and Money Market
In simple terms, an interest rate cut to zero and below makes this asset class even less attractive to investors looking for income. Some Isa accounts are already paying as little as 0.01% interest after the Bank of England's emergency rate cuts, so savers are likely to continue to suffer after a wave of cuts in 2020. The "free banking" model is likely to come under further pressure in the UK if rates are negative - while banks are unlikely to risk the wrath of customers by charging them for holding deposits, a monthly or annual account charge is one way for companies to recoup their money.
Money market instruments, which are liquid and pay better rates than savings accounts, saw strong inflows in some months of 2020. Of course a drop in interest rates will affect money market income but if they still yield above negative, this will keep them in favour with professional investors needing a liquid, short-term home for their money.
Property
The UK housing market appears to be buoyant despite further lockdown measures and mortgage rates remain very competitive, with approvals at record highs. Another rate cut is likely to make borrowing even cheaper but those holding out for a product which pays you to borrow money may be disappointed.
What has happened in countries that have had negative official interest rates for many years now? Denmark has had negative interest rates since 2012, with provider Nordea Bank now offering a 20-year product at 0%. The country's Jyske Bank does have a negative rate mortgage product - but you still have to make monthly payments, it's just the capital outstanding reduces faster than conventional products.
Commercial property in the UK has taken a step back with lockdown measures keeping bars, offices, restaurants and shops closed at the start of the year. While lower interest rates increase the attractiveness of rental yields in the residential and commercial property markets, there are risks attached: commercial property giant British Land (BLAND) said it had collected less than half of the rent owed from tenants in December.
