The Bank for International Settlements (BIS), better known as the central bank for central banks, recently released an analysis of the latest and greatest monetary policy ammunition in central banking, negative interest rates. The analysis looks at the implications of a negative interest rate environment and the uncertainty that it creates for both individuals and institutions.
With policy rates hovering close to the zero lower bound for most of the world's most influential central banks, the weak global economy has caused four of Europe's central banks to implement an untried and untested policy, moving their interest rates below zero. Outside of Japan who most recently adopted this novel approach to stimulating growth, the Danmarks Nationalbank (DN), the European Central Bank (ECB), Sweden's Sveriges Riksbank (SR) and the Swiss National Bank (SNB) have all introduced negative rates as shown on this graphic:
As you can see, each of the four central banks lowered its rates further into negative territory in a number of steps as it appeared that the policies were not having their intended affect.
Each of the banks had different reasons for taking this drastic (and desperate step) including countering low inflation, currency appreciation pressures and pegging an exchange rate floor. This interest rate game started with the ECB who moved to a negative rate in mid-2014 to "underpin the firm anchoring of medium to long-term inflation expectations" in other words, to prevent deflationary pressures, and on March 10, 2016, further lowered the rate from -0.03 percent to -0.04 percent. The Riksbank adopted a negative policy during Q1 2015, again, to "safeguard the role of the inflation target as a nominal anchor for price settling and wage formation". In both cases, the central bank continued its other unconventional monetary policies of purchasing assets including government bonds and other asset-backed securities, moves that have likely put upward pressure on longer term interest rates. Interestingly, in the case of Sweden, the Riksbank will own 30 percent of outstanding government debt by mid-2016. The Swiss National Bank opted for a negative interest rate policy in December 2014 (-0.25 percent) to maintain a floor on the value of the Swiss franc which had appreciated substantially as capital flooded into the Swiss "safe haven". Upward pressure on the value of the franc continued, making Switzerland's exports more expensive, and the SNB lowered its interest rate further to -.0.75 percent in January 2015. Denmark's central bank saw a surge in demand for the Danish kroner after the Swiss National Bank's decision and, in order to prevent further currency appreciation, cut its negative interest rate to -0.75 percent in early 2015. Once the value of the kroner had stabilized, Denmark's Nationalbank raised its key policy rate to -0.65 percent. As you can see, the interactions between these four central banks has led to a "rush to the bottom" with the three national central banks being forced to lower their rates further to prevent their own national currency from becoming increasingly overvalued. Perhaps one could term this as an unintended consequence of poorly executed central bank policies.
What impact has this had on the economies of these countries? Let's look at the impact on money markets. So far, these modestly negative policy rates have seen the rates being passed on to other money market rates (i.e. T-Bills, lending rates, overnight rates, CDs etcetera) as you can see on these graphs:
In all four jurisdictions, the overnight rate (the interest rate at which financial institutions borrow and lend funds among themselves or the rate at which the central bank charges financial institutions to borrow money overnight) has tracked the negative bank rate. While the point of negative interest rates was to prod banks to lend, evidence suggests that banks are able to avoid negative rates by extending maturities or lending to riskier counterparties.
Now, let's look at what has happened to other interest rates that are of greater interest to households:
While the banks have passed along the costs of negative interest rates to their wholesale depositors, they have not done so for households. As you can see, deposit rates for retail depositors (i.e. you and I) have not been pushed into negative territory, largely because the banks were concerned that such a move would create a run on deposits as customers fled to cash, a situation that seems to have occurred in Japan where there is a reported shortage of house safes and rise in demand for 10,000 yen notes. As well, it is interesting to see that interest rates on mortgages have risen in Denmark, Sweden and Switzerland since a negative interest rate environment was implemented. This is a critical problem since the entire point of negative rates is to get consumers and businesses to borrow until it hurts. If negative interest rates are not passed along to household and corporate borrowers, there is absolutely no reason for implementing a negative interest rate policy. In a perfect "damned if you do, damned if you don't" scenario, if banks do implement a negative interest rate policy on their lending rates, there could be significant negative impacts on bank profitability unless negative rates are imposed on deposits which could result in a run on deposits. So far, in the nations with a negative interest rate policy, there has not been an abnormal increase in the demand for currency but this is likely related to the fact that negative interest rates in these jurisdictions have not been passed along to consumers.
Let's close this posting with a quote from the analysis, keeping in mind that both the Federal Reserve and the Bank of Canada have already floated negative interest rate trial balloons:
"So far, zero has not proved to be a technically binding lower limit for central bank policy rates. Nonetheless, there is great uncertainty about the behaviour of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period. It is unknown whether the transmission mechanisms will continue to operate as in the past and not be subject to "tipping points". Furthermore, an extended period of negative interest rates has so far been limited to the euro area and neighbouring economies. It is not clear how negative policy rates would play out in other institutional settings." (my bold)
Central banks are opening a monetary policy "Pandora's Box" with their latest imaginative policy, one that may be difficult to close in the future.