8:10 am, October 28, 2020
The Bank of England has been very open in its admission that negative interest rates could be introduced.
The UK has never taken rates below zero before, but with rates already at the historic low of 0.1 per cent, policymakers have few tools left in the box to help offset the economic hit from the pandemic.
But what could negative interest rates mean to car dealers and car buyers?
Here we talk to accountancy expert Paul Daly from UHY Hacker Young about what the prospect of negative interest rates could mean to the motor industry.
What are negative interest rates?
A negative interest rate is when a central bank’s base rate goes below zero per cent.
The base rate determines how much interest the central bank pays to financial institutions that hold money with it, and what it charges them to borrow.
Lenders use the base rate to price the interest they pay on savings deposits and the interest they charge on loans and mortgages.
Why is the Bank of England considering negative interest rates?
Since the financial crisis, many central banks around the world have already taken their base interest rates below zero, including the European Central Bank and its counterparts in Japan, Denmark, Sweden, and Switzerland.
Negative rates have been used to bolster flagging economies and the Bank is looking at whether it could be used on these shores to help the UK weather the impact of the coronavirus pandemic and lockdown restrictions.
What would negative interest rates mean to car dealers?
Daly said: ‘Any move to negative interest rates would primarily be a move to stimulate the economy. If successful, it could mean a boost to levels of consumer activity which in turn would be beneficial to car dealers.
‘There may also be an impact of more cash rather than financed deals as customers look to utilise savings that might otherwise be costing them money on negative rates.’
How do negative rates help boost economic growth?
The idea is to encourage banks to increase lending to households and businesses, because the Bank of England would charge them money to hold their cash.
It is also designed to spur households and businesses on to spend, rather than leave money in their bank accounts, where the value would be eroded by inflation.
Another benefit is that negative rates would make it cheaper for the government to borrow money, which would help cut the ballooning bill for Chancellor Rishi Sunak’s Covid-19 spending spree.
Could negative rates cost car dealers if they hold a lot of money in the bank?
Daly says: ‘This is definitely the case for other countries which have already experienced negative interest rates.
‘Typically it is the largest deposits that attract a negative rate, with smaller deposits having a floor of 0 per cent return.’
Will negative interest rates mean car finance gets cheaper?
‘In reality, this will not be the case and this is demonstrated by today’s extremely low bank rate of 0.10 per cent and yet the cost of car finance is far in excess of this,’ explains Daly.
‘Other than supported rates on new vehicles, the cost of car finance may reduce, but only slightly. For example a move from 0.10 per cent to -0.10 per cent may reduce the cost of borrowing on car finance by the same 0.2 per cent overall.
How can car dealers prepare for negative interest rates?
Daly says many dealers have extended their borrowings and stock piled cash as a result of the economic risks associated with the pandemic.
He added: ‘These large cash reserves risk having an additional cost associated with them if negative rates are imposed.
‘It is important to ensure that flexibility in financing structures is maintained and that this stock pile can be utilised quickly and without cost to reduce debts if required.
‘The obvious solution therefore is to ensure cash stockpiles are maintained from short term facilities such as stock funding, overdrafts and revolving credit facilities over longer term funding.’
What are the other downsides of negative interest rates?
One major concern is that sub-zero rates can squeeze bank earnings by narrowing the gap between money made on loans and paid out on savings.
This could potentially affect their ability to lend and have a knock-on effect on the stability of the UK financial system.
As seen in the financial crisis, keeping bank lending flowing is vital for the entire world economy.
Are we likely to see negative rates any time soon?
The Bank wrote to all the major lenders and building societies on October 11 to ask if they are ready should rates go negative amid fears it could play havoc with their systems.
Banking systems are not set up for rates to go to zero or below as they were designed for positive values.
It would likely take weeks for banks to get their systems prepared, while the Bank itself is also still researching whether or not the side-effects outweigh the benefits of negative rates.
The Bank’s own chief economist has said it would be many months before the Bank’s research on the feasibility of negative rates is complete, suggesting 2021 at the earliest for the tool to even be considered on these shores.
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