The backlash is growing against negative interest rates. Is the regime in its final act, or will negative rates remain in the central banks' toolbox? Nordea Research takes a deep dive into the issue.
Concerns are mounting over negative interest rates, the unconventional monetary policy tool used by central banks in Europe and Japan to spur economic growth.
In a new report, Nordea Research delves into the debate, the unintended side effects and whether central banks are likely to abandon the device anytime soon.
“Scepticism over the effectiveness of negative rates and worries about the side effects are growing. This could influence central bankers’ decisions whether to wade deeper into negative territory or steer away from it”, says Torbjörn Isaksson, chief analyst on Nordea’s macroeconomic research team.
Read the full, in-depth report, “Central Banks: Giving up on negative rates?”
And hear the co-authors discuss highlights from the report in the related podcast.
How low can you go?
After the global financial crisis of 2008, many central banks cut interest rates to near zero. Facing sluggish economic growth and with no room to cut rates further, some central banks resorted to the drastic measure of a negative rate policy. Under such a policy, financial institutions are charged interest on their central bank deposits to encourage them to lend instead of hold onto cash, thus driving economic activity and growth.
The Nordic region, except for Norway, has been at the forefront of the negative rates experiment. Denmark went sub-zero in 2012, followed by the euro area in 2014, with Sweden and Switzerland close behind in 2015. Japan followed suit in 2016. What was originally intended as a temporary measure for extraordinary times has since become a mainstay in these areas.
Sweden, however, has recently shown signs of starting to backpedal. In October, the Riksbank sent clear signals of a rate hike to zero in December 2019, warning of the “negative effects” that could arise if negative rates are perceived as a permanent state.
Avoiding unwanted effects
There are reasons to be concerned, according to Inge Klaver, a Nordea Research analyst and co-author of the report.
For one, insurance companies and pension funds are struggling to meet their commitments, due to ultra-low returns on the share of assets they must keep in safe bonds. In addition, low interest rates encourage more risk-taking and increased debt, which drives up the prices of financial assets as well as homes and real estate. Negative rates can also hurt bank profitability and thus end up reducing lending and credit creation.
Yet while Sweden may seem ready to abandon the experiment, Denmark, which together with Switzerland has the most negative rate in the world, still appears to be rooted firmly below zero.
“The Danish authorities have implemented a range of measures to tighten financial conditions and avoid any bubbles or unwanted effects. It doesn’t look like the central bank is going to do a U-turn anytime soon,” says Jan Størup Nielsen, chief analyst in Nordea Research.
In the latest development, an increasing number of banks in Denmark have decided to start imposing negative rates on private deposits above a certain threshold.
“That opens up the next frontier in a country where negative rates are becoming the new normal”, says Størup Nielsen.
Read the full, in-depth report from Nordea Research: “Central Banks: Giving up on negative rates?”
And hear directly from the co-authors in this related podcast.
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