With the Bank of England’s base rate being at an historic low of 0.1%, there is talk that we will soon see negative interest rates.

In the past, Andrew Bailey, Governor of the Bank of England, had not been in favour of such a step but has admitted that he is now not ruling it out in order to kickstart the economy.

The Bank is under pressure to push interest rates below zero as data has shown that inflation dropped from 1.5 per cent in March to a four-year low of 0.8 per cent in April. Low inflation might sound good but it can suppress economic growth and prevent wages increasing. The bank’s usual target is to keep inflation around 2% but lockdown has understandably had a severe effect on spending so economists think inflation will stay low for some time.

How would negative interest rates work?

Anyone wanting to deposit money with the Bank of England, such as high street banks, would have to pay to do so. This is designed to encourage the banks to lend to households and businesses.

Negative interest rates have already been used as a tool by the European Central Bank and Japan. Typically, the Bank will lower interest rates when the country is facing a recession because it encourages borrowing and spending which stimulates the economy. But negative interest rates are controversial as it is felt they have limited effectiveness in encouraging spending and investment in the long term.

They also do little to encourage companies to keep a cash buffer in times of crisis which, as many have found during the coronavirus outbreak, has been crucial.

What would the effect be on your mortgage?

If you have a fixed rate mortgage, the most common type, it would not be affected. If you have a variable rate mortgage that follows the standard variable rate of the bank that made the loan, or a tracker mortgage that follows the Bank of England base rate, it could fall a little if the base rate is cut.

It’s likely, however, that any drop would be limited by certain terms and conditions. Most tracker mortgages these days have a ‘collar’ which stops the lender having to cut the rate at all. It’s worth checking your paperwork to see whether your lender has specified the lowest rate it would ever charge.

Could new mortgages be free?

Denmark has shown this could be a possibility. The rate, last year, for borrowers at Jyske Bank was -0.5% which meant the total sum they owed each month fell more by more than the sum they had repaid. That’s a great kind of mortgage! Although it looks like the UK is a way off that.

While fixed term mortgages are falling in price, some tracker mortgages have been withdrawn and re-priced with larger margins to protect lenders against falling rates.

A negative base rate would mean banks and building societies would have to pay to keep money on deposit. The thinking behind this policy is that it would encourage them to lend instead.