Concerns about the health of the global economy and volatility in financial markets have prompted some central banks to use negative interest rates as a policy tool to stimulate growth. But experts warn a spread of the policy might lead to unintended consequences.
Negative rates are increasingly being seen as a viable option for central bankers after the Bank of Japan decided to move rates below zero at the end of January, which also sent the country’s 10-year treasury rates into negative territory for the first time ever.
The central bank, led by Haruhiko Kuroda, also said it will push the rate even lower “if judged as necessary”.
The European Central Bank, the Danish National Bank, the Swiss National Bank and the Swedish Riksbank have also all pushed key short-term policy rates into negative territory.
The US Federal Reserve has also suggested it could introduce sub-zero rates months after its long-awaited rate hike.
But is the adoption of such a policy really effective in boosting demand? And will major economies such as the US or UK follow suit?
M&G Investments fixed interest investment specialist Pierre Chartres says “the jury is still out” on the potential unintended consequences of charging investors to hold money with central banks.
However, he says: “The negative side-effects of a prolonged period of negative interest rates are erosion of bank profitability, pressure on non-bank financial institutions such as pension funds and life insurance companies, added pressures on savers who will then be inclined to save even more and increases in real terms on the value of outstanding debt.”
Pimco chief investment officer of US core strategies Scott Mather says in addition to a widening of credit and equity risk premiums, negative interest rates make the “safest” asset classes like government and other high-quality bonds riskier.
He says: “As yields are pushed into negative territory, holding these bonds represents a guaranteed loss of purchasing power if held to maturity.”
But JP Morgan Asset Management global market strategist Alex Dryden says negative interest rates on a benchmark basis are not “the final frontier” as long as they do not impact on consumers and the real economy.
He also argues the scale of overall bank assets actually exposed to negative rates remains relatively minimal.
In the euro area, for example, this is 2.2 per cent of banks total assets, while in Japan it is 0.9 per cent.
He says: “The reason for this small impact is because most central banks are using a tiered system, meaning only some assets are affected. In aggregate, less than 4 per cent of bank assets in the five negative rate regimes are impacted, suggesting investors should keep the challenges of negative rates in perspective.”
Hermes Investment Management chief economist Neil Williams argues the negative interest rates loop seems to be picking up in Europe and believes the trend could continue.
In December, the ECB cut the overnight deposit rate from -0.2 per cent to -0.3 per cent in an attempt to push banks to lend.
And last week Sweden’s Riksbank pushed rates further down from -0.35 to -0.5 per cent.
Williams says: “The effectiveness of these negative deposit rates is likely to be via keeping long yields down rather than directly boosting loan demand, given the ECB’s commitment to buy government bonds down to a yield as low as the deposit rate.
“With some two-thirds of eurozone private borrowing being long yield, rather than short-rate driven, further rate cuts seem the more convincing route to growth.”
The US and the UK have until now been able to avoid being dragged into the negative rates phenomenon, but experts say the move from other central banks may encourage them to follow suit.
Williams says the Fed and the Bank of England have “more options at their disposal” with their rates still positive, and they are more likely to raise rates “even though market pricing infers this is off the cards until 2017 or 2018”.
In November, a month before the US increased rates, Federal Reserve chair Janet Yellen told a House of Representatives committee if the economy worsened, “potentially anything, including negative interest rates, would be on the table”.
However, in a speech to the House Financial Services Committee last week, Yellen said: “I do not expect we are going to be soon in the situation where it’s necessary to cut rates.
“I continue to think many of the factors holding down inflation are transitory. We want to be careful not to jump to a premature conclusion about what’s in store for the US economy.”
Hargreaves Lansdown senior analyst Laith Khalaf says while it is unlikely the UK will adopt a negative interest rate policy, the possibility should not be ruled out altogether.
Khalaf says: “Negative interest rates could spread to the UK as the market is now pricing in a higher chance of an interest rate cut than a rise.”
Earlier this month, former FSA chairman Adair Turner warned the UK faces “almost indefinite” low interest rates without radical action as the UK economy is still “stuck in a chronic malaise” because of inadequate growth.
Turner said interest rates may not rise to the BoE’s 2 per cent target before 2020.
Khalaf says: “If the Government decides more stimulus is necessary I suspect quantitative easing is a more likely bet than moving into negative interest rates because it would have a bigger impact.
“But as long as the economy keeps trundling along and inflation remains low, I suspect the status quo will be maintained for the foreseeable future.”