UBS: What are the benefits and limits of sub-zero interest rates?
How low can central banks go? Until recently it was assumed that policy makers had to stop once they had cut nominal interest rates to zero. But negative interest rates – charging commercial banks for the privilege of holding reserves with the central bank – are being more widely deployed.15.02.2016 | 09:53 Uhr
Countries accounting for almost a quarter of global GDP now have sub-zero interest rates –includingthe Eurozone, Switzerland, and most recently Japan.
Even in the US, where 100bps of rate hikes were priced in at end-2015, markets now attach a 10% chance (four times higher than the start of this year) that the Fed will impose negative rates over the next 12 months, in response to softer current economic activity indicators. Those central banks that have gone negative believe it could boost growth and markets in several ways. First, the policy should encourage commercial banks to make loans to avoid charges on cash in excess of mandatory reserves.
Second, sub-zero rates also have the potential to weaken a nation’s currency, making exports morecompetitive and boosting inflation as imports become more expensive. In addition, by lowering short-datedgovernment bond yields, negative rates should increase the relative appeal of equities, helping that market.
Finally, negative rates may complement other easing measures (like QE), and signal central bank resolve to tackle persistently below-target inflation.
That is the theory. But the brief history of negative rates shows things haven’t always gone according toplan. So what are the limits of the policy and its possible unintended consequences?
Credit conditions might actually tighten: For negative rates to boost bank lending, commercial banks mustbecome willing to lend more, and/or at lower costs. A sticking point is that negative rates tend to squeezebank profits – trimming the gap between the rates at which they borrow and offer loans. If profits suffer too much, banks may even scale back lending. Difficulties in imposing negative rates on depositors may meandebt costs rise for other consumers; Swiss and Danish banks have hiked borrowing costs for homeownerssince negative rates were introduced.