Sub-zero rates are no silver bullet

1 June 2020

The COVID-19 crisis has already pushed many central banks to cut interest rates close to zero. And with many economies continuing to contract, the concept of negative rates is once again back in the spotlight.

Negative rates upturn the normal borrower-lender relationship by imposing interest rate costs on those sitting on cash, encouraging them to spend or invest the money instead. Supporters of negative rates hope they will spark growth and inflation, partly by lowering bond yields and weakening currencies, and give central bankers more room to manoeuvre on quantitative easing. But it has rarely worked out like that.

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Five central banks have experimented with negative policy rates in recent times (the European Central Bank, Bank of Japan, the Swiss National Bank, Sweden’s Riksbank and Denmark’s Nationalbank). In economies with negative rates since 2015, the average core inflation print has been just 0.8 per cent. Even in Sweden the main inflation metric has only edged over 2 per cent in two months of the past five years, both times as a result of a methodology change.

On the growth front, things look a little more promising. Sweden and Denmark have both seen relative booms over the past five years – with Sweden growing at more than 4.5 per cent year-on-year in the second half of 2015, shortly after negative rates were introduced. But this masks the fact that this rapid growth rate was as a result of an unsustainable property boom (residential investment up 20 per cent year-on-year) – which crashed in 2019 – and a wave of migration-based spending. Elsewhere, growth has been much tamer.

The negative consequences have been telling. In Switzerland, the local bankers’ association says it has done “massive structural damage” to the economy. In Sweden, feedback from consumers and businesses played a big role in persuading the Riksbank to move the repurchase rate back to zero. At a time when confidence needs to be lifted, and banks need to lend, negative rates seem misguided.

Despite markets pricing in the chances of the Federal funds rate turning negative, US Federal Reserve Chair Jerome Powell has stressed that negative rates are not under discussion at the Federal Open Market Committee, which is responsible for setting US rates. Indeed, the Fed’s actions and rhetoric since March make it clear that the policymakers intend to rely on other policy tools first. In just over two months, the Fed has purchased more than USD2 trillion in Treasury and mortgage-backed securities. Powell has described the primary goal of the purchases as restoring the functioning of these markets, rather than putting downward pressure on longer-term interest rates.

In the UK, senior Bank of England figures have recently mentioned negative rates. Chief Economist Andy Haldane, for example, was quoted in a newspaper on 17 May as saying that negative rates (as well as other policy options such as buying riskier assets than government bonds), were being looked at “with somewhat greater immediacy” in light of the COVID-19 pandemic.

We don’t expect policy rates to go negative in the UK or the US in our base case forecasts, but they are on the radar – particularly in the UK. They could be a risk worth taking if the recession intensifies, but experiences elsewhere suggest that the benefits of negative rates are not immediately clear.

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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: James Pomeroy

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