Pensions experts have warned cutting the Bank of England base rate below zero could force annuity rates down and inflation up, causing an “unmitigated disaster” for savers.
Last month, Bank of England deputy governor Paul Tucker told MPs at a Treasury select committee he has raised previously the idea of setting negative interest rates.
Tucker conceded this would be an “extraordinary” move and would require careful consideration by Bank officials.
He said: “I hope we will continue to think about whether there are constraints to setting negative interest rates. This is an idea that I have raised. This would be an extraordinary thing to do and it needs to be thought through very carefully.”
The base rate has been held at 0.5 per cent since March 2009.
The primary aim of a negative interest rate policy would be to encourage high street banks to lend money to businesses rather than depositing it with the BoE.
However, experts say banks are more likely to react by purchasing more Government gilts. As demand for gilts increased, the price of these gilts would fall.
Falling gilt yields would hit annuity rates and cut the maximum income someone in capped drawdown could take.
Hargreaves Lansdown pensions analyst Laith Khalaf says: “The Bank of England would be hoping that a negative interest rate would boost lending in the real economy, particularly to small businesses.
“But in reality the credit-worthiness of businesses has not changed, so the rational thing for banks to do would be to buy gilts.
“That would drive gilt yields down, which would be bad for anyone who wants to buy an annuity and bad for drawdown.”
Independent pensions consultant Ros Altmann says cutting rates also risks creating inflation. This would have a negative impact on anyone whose pension income is not inflation protected.
Altmann says: “The risk with continually bringing rates down is that it will create inflation and that is terrible for pensioners. This has the potential to be an unmitigated disaster for savers and it smacks of panic.
“If interest rates have not moved the economy when they are almost at zero, why do we think bringing them down even further is suddenly going to work?
“It is the economics of the madhouse. Bringing rates down seems to be the only policy option being considered, and to hell with savers and pensioners and people who try to do the right thing.
“At a time when the Government is trying to encourage saving through automatic enrolment, the Bank seems intent on destroying incentives to save.”
Forty Two Wealth Management partner Alan Dick says: “My gut feeling is this would be bad for savers and annuity rates would tumble, but the reality is nobody knows for certain what the reaction would be.
“It could create chaos and if the investment markets react negatively that would be bad news for everyone.”