What impact will negative interest rates have on ISAs?

In a letter signed by Sam Woods, Deputy BoE Governor, banks were asked whether they would be ready if the BoE base rate was to move into negative territory. 

The letter, published on October 12, stated: 'For a negative bank rate to be effective as a policy tool, the financial sector – as the key transmission mechanism of monetary policy – would need to be operationally ready to implement it in a way that does not adversely affect the safety and soundness of firms.'

The possibility of negative interest rates first hit the headlines in May, when Andrew Bailey, speaking to the Treasury Select Committee, revealed that policymakers were assessing the experiences of other central banks that have used negative rates.

The announcement came after two emergency moves in March saw the BoE base rate cut from 0.75% to 0.25%, and then further to 0.1% (the lowest on record) in a bid to prop up the UK economy in the wake of the effects of the COVID-19 pandemic. 

It also followed the sale of negative-yielding government bonds in the UK for the first time ever, where £3.8 billion of three-year gilts at a yield of -0.003% were sold to investors who will get back less than they paid upon maturity. 

But what would negative interest rates mean for those holding - or considering - an ISA?

Low interest rates on Cash ISAs and consequences for the Stocks and Shares ISA

When negative interest rates were first suggested, Cash ISA rates were already at significantly low levels, with the best easy-access Cash ISA on the market sitting at 1.01%. Now, this has dropped to just 0.6%. 

With inflation fluctuating between 0.8% and 1.5%, in some cases, Cash ISAs are struggling to keep pace with inflation - which of course means the value of savings may well be eroded over time.

The introduction of negative interest rates may result in a reduction of the rates offered on Cash ISAs - meaning investors could be receiving very little to no interest on their savings, while running the risk of increased fees. 

As negative interest rates effectively mean commercial banks will be charged a fee on the deposits that they hold at the central bank, there is the possibility that some of this cost could be passed down to the investors. However, it’s considered unlikely that banks would make this move, as they fear customers may pull their money from the bank in favour of other, less traditional methods of storing cash.

Investors holding a Stocks and Shares ISA may also feel the consequences of negative interest rates, as dividend-paying companies see decreased yields. 

The impact of the alternative finance market and the IFISA

The alternative finance market is likely to play a significant role in the bounce-back of the UK economy. 

SME and property backed lending through the peer-to-peer and debt-based securities market have been crucial in supporting both small and medium-sized businesses and property development projects in the aftermath of the 2008/09 financial crisis, and they’re expected to be just as critical in the fallout of the COVID-19 pandemic.

This was evidenced when the Government announced that peer-to-peer lenders were eligible to apply for accreditation from the British Business Bank (BBB) to take part in the Coronavirus Business Interruption Loan Scheme (CBILS), which was introduced to provide financial support to small and medium-sized businesses affected by COVID-19.

The Innovative Finance ISA (IFISA) - which allows investors to hold peer-to-peer loans and debt-based securities under the ISA tax wrapper - offers investors a tax-efficient way of supporting businesses and regional house builders, in turn having a positive impact on the economy and society. 

Explore the benefits of aCARLTON Bonds IFISA:

The IFISA is uncorrelated to the BoE base rate, meaning in the event of a drop to negative interest rates, they would be affected to a much lesser extent than the likes of a Cash ISA. 

The underlying asset of an IFISA is an important factor in determining whether - and if so, how - it will be affected by the current pandemic. 

The incredible pent-up demand for housing that emerged after the easing of the first lockdown in May, and that has continued in the months since, is a positive indicator that property lending through an IFISA will continue to be vital.

The CARLTON Bonds IFISA

Helping you to make your money work harder. Targeting tax-free returns of up to 7.75% per annum.

CARLTON Bonds provide investors with access to fixed term investments by generating returns from making secured loans available to experienced companies within the UK’s property sector.

Our approach enables investors to benefit from higher interest rates when compared to many other alternative investments, whilst supporting the UK’s residential and commercial property development market.

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Originally published May 23 2020, updated November 26 2020.