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By Sarah Modlock
Your money in a 0% interest world
It sounds like a laxative and that's pretty much the idea. 'Quantitative easing' is the name and loosening up the economy is the game. Known in layman's terms as 'printing money', this isn't actually about the governor of the Bank of England cranking up the presses and churning out a few billion extra quid in tens and twenties. In reality, it means the Bank will buy billions of pounds worth of assets such as government bonds to flood extra cash to the economy in the hope that the cost of borrowing drops. If this sounds like a desperate measure, that's because it is. It's not something that happens lightly but, as the Treasury says, "It would be prudent to consider all the options." It is also risky as it could push up inflation, although this could provide a boost in our current climate of the more worrying 'deflation'. Japan has been using quantitative easing for a decade now as part of its own battle with deflation - where prices drop but consumers wait for them to fall further before spending and in the process, manufacturers start failing. Economists in the US are currently operating a form of quantitative easing in their efforts to stabilise the financial system. The Federal Reserve has committed to purchasing large amounts of mortgage-related debt to help the housing market, and it is considering outright purchases of government bonds. Why is this being considered in the UK? Quantitative easing is usually considered once zero interest rates start looming into view, as they are now. According to minutes of the Bank of England's rate-setting body, the monetary policy committee voted 9-0 to cut rates to 2% in December and considered a bigger move, but pulled back because it was worried about the impact on sterling. Their latest move reduces rates to a historic 1%. Consultancy Capital Economics is forecasting that Bank rate will hit 0% in March or April, while UBS and Deutsche both predict the low to be 0.5%. We currently have the lowest rate since 1951 but many analysts believe it needs to fall further still. A zero rate of interest represents unchartered territory for the UK and so we should expect the unexpected with Messrs (pun intended) King and Darling. Without scaremongering, it seems that the last 12 months of tactics - nationalising banks, driving down interest, reducing VAT and pouring billions into the economy - are not having the desired effect. The pound has slumped, job losses are soaring, the high street is imploding and the property market is stagnating. Increasingly dramatic and risky remedies are all that is left. "We now need to go further, to ensure banks can resume lending to businesses, which is absolutely critical," the Chancellor commented. "I think there are a number of things we can do, we are discussing them with the banks, and we will be able to say something shortly." The Treasury is already believed to have modelled how this might revive the economy. Of course we would expect nothing less. The chairman of the Treasury Select Committee, John McFall, said that "the situation we're in globally is so dire that we need to have extraordinary measures on the agenda". Hopefully, if it is the right approach, the talking wont delay the doing. Zero interest rate policy needs to be applied in a timely way and if the Bank leaves it too late it is unlikely to have much traction. What happens if it doesn't work? Perhaps the really constipating factor for banks and financial institutions is that wholesale money - on which they depend for much of their funding - is getting more expensive. Some high street lenders say they cannot afford to borrow unless they charge their customers a lot more. They need to maintain a profit margin to sustain their businesses. Not only is the funding costing more, there is less of it available. This is why the Chancellor is failing to persuade many banks to pass on the full interest rate cuts at the moment. The knock-on effect for the man in the street is the same as for banks - less credit and what is available is more expensive and only offered to those who don't really need it. Until the fluidity returns to both wholesale and retail credit markets, we are going to struggle. It's likely that this will take time. Things will be grim if rates fall to zero, inflation hits negative figures and everyone hangs onto their cash and stops spending, compounding the problem. This 'liquidity trap' would demonise savers and encourage us to 'spend for victory'. I think you could be forgiven for thinking this is already happening.... Your money in a zero interest world.... Savings - Ugh, shame on you. Only kidding. But the rates you can expect are no joke. Shockingly, around a quarter of accounts now pay below 1% but if you shop around you can still earn up to 5%. Anglo Irish Bank's Easy Access Deposit has a variable rate currently at 5% and the Scarborough Building Society Balance Builder - also variable - offers 4%. Fixed rate account returns are falling but if you can lock your money away for one, two or three years then a fixed-term bond may deliver a healthier rate of fixed interest. The Anglo Irish Bank one-year bond pays 5% and Cheshire Building Society is currently paying 4.5% for a year. Some accounts - notably part of the range from National Savings (NS&I) and Leeds Building Society - have interest linked to inflation. Make sure you know what you would get if inflation fell into negative numbers. It's entirely possible that savers will everntually be faced with the prospect of paying banks to keep their money in an account. No doubt this will lead to the sale of even more home safes and further tightening on lending as savers whip their money out of banks and keep it at home. Mortgage - If your current mortgage is designed to track the base rate then make sure there is no collar attached (below which the rate will not fall, regardless of the base rate) and find out what your lender will charge in the event of zero interest base rate. In many cases, your initial mortgage fee was designed to offset the potential for additional costs to the lender so they should not be over-charging down the line. If you venture into negative interest then this will usually pay down your capital so don't expect a cheque in the post. It's worth clarifying what your lender plans to do if and when this happens. In conditions of low inflation or deflation, the real cost of the mortgage diminishes only slowly throughout the term of the loan - so it makes sense to reduce it as much as you can. If you can afford then consider the benefits of overpaying your mortgage while rates are low. This will reduce the term and save thousands in interest. Pension - Advisers are urging those who are comfortable with their pension pot to buy an annuity sooner rather than later, as rates are set to tumble, leaving you with a smaller income. "We expect rates to fall by another 10%. Shop around before you buy as it can add about 20% to your income," advises Hargreaves Lansdown's Tom McPhail. "The absolutely crucial golden rule is to shop around before you buy; the average increase in your income if you do so is around 20pc, but it can be much more," he adds. Credit card - Paying off debt remains crucial and there are plenty of 0% balance transfer deals still available, although more cards now charge fees. For purchases, keep an eye on the interest-free period as these are shrinking. Figures from Moneyfacts.co.uk correct as at 29 December 2008. 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