News, opinion, interviews and business insights from legal industry leadersSubscribe
Sometimes you feel you couldn’t really make it up. Do you remember the days when banks used to pay you a reasonable rate on your deposit account? Well barely. It seems like a long time ago now. So would you believe that a bank might now be asking you to pay for the privilege of depositing your money in one of their bank accounts? Or even give you less than you put in?
I remember describing to some colleagues how Switzerland, some decades ago, charged depositors for the privilege of keeping money with them. It caused a certain amount of laughter and disbelief then. “Why would I want to pay a bank to keep my money, or more to the point, get less back than I put in? After all, I could put my £1,000 under the mattress and get back £1,000”. No-one’s laughing any more. Bad news for us, bad news for banks, but great news for secure mattress manufacturers.
So since 2008, rates have dropped to near zero in most developed nations as policy makers and central banks have sought new ways to try and manage economies after the banking crash. However, almost a quarter of the world’s economy now has sub-zero interest rates, including Switzerland, Sweden, Denmark, the Eurozone and, most recently, Japan. This now accounts for some US$7 trillion of negatively priced government bonds around the globe.
Is this market madness? Or is there some strange logic behind it? And more to the point – will it work?
So what are the reasons and intentions?
1. To encourage banks to lend more – or at least encourage them to lend something. If they have to pay central banks for holding excess reserves on their books, then there is a greater incentive to try and lend it out. Quite logical. However, it took a while for the Bank of England to clock that many British banks took the QE money and left it in their Bank of England accounts earning 0.5% instead of lending it on.
2. Sub-zero rates will quite likely weaken a country’s currency and make imports more expensive whilst at the same time making their exports more attractive.
3. Sub-zero rates will, or should, lower the value of short dated government bonds, and thus encourage investors away from bonds into hopefully higher returning equities.
4. Firmness of resolve. For those countries with negative interest rates, it is a strong message from the central bank that along with other financial measures (like QE), they will be doing all they can to address growth and inflation and getting the economy moving again.
Those of course are all logical moves – but will they work?
One of the largest issues for central bankers is how to address the question of small savers who have been hard pressed over the past few years. Would the authorities really expect loyal savers to have to pay banks for their deposits and get back less than they put in? After all, many elderly citizens have always looked at their cash reserves as their easy income plan for old age. Not anymore. It’s a strange world where I can get a better return on cash held with a power provider (OVO) than at a bank! I suspect the Bank of England may well be working on a mechanism to allow cash investors some exemption from a negative deposit account – either that or face a savers’ revolt!
Then, of course, there is the question of lending. Negative rates will squeeze bank profits and so they could have less to lend anyway, thus scaling back lending. Alternatively they may decide to raise the cost of money to other borrowers, as we have seen in Switzerland and Denmark, where mortgage lending costs have risen.
What about the impact on equities – surely they would go up? Well given that many indices are heavily weighted into banks, and if those banks are being squeezed on profits by negative rates, then their shares may well weaken some of the indices with them. So certainly this is not a ’dead certain’ bet.
As for the impact on foreign exchange and potential for weakening a nation’s currency, a cursory glance at the Japanese Yen shows that since their policy change towards negative rates, the currency actually strengthened against the Dollar by over 5%.
So will all of this encourage us to take our money out and spend it to keep the economy going, or will it just encourage us to hide it under the mattress? What it does show is that the policy makers are going to consider every action, no matter how unlikely it seems, to keep the economies moving.
Thus what may be seen as a logical action may not necessarily result in the anticipated reaction. Beware the law of unintended consequences.