InvestmentsSep 29 2015

Negative interest rates: Into the red

      pfs-logo
      cisi-logo
      CPD
      Approx.30min
      pfs-logo
      cisi-logo
      CPD
      Approx.30min
      twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
      Search supported by
      pfs-logo
      cisi-logo
      CPD
      Approx.30min
      Negative interest rates: Into the red

      Four years ago a woman in Beijing bundled 100,000 yuan (approximately £10,192) in a plastic bag, put the bag in a metal container, and buried it under her kitchen floor. When the woman returned to the buried funds last month she discovered that the notes had disintegrated, turning to mush. The near unrecognisable notes had lost all their value, and will likely not be redeemable at any bank for exchange.

      While burying money below one’s kitchen floor may seem like an extreme measure, it highlights the lingering mistrust of banks. Since the financial crisis, consumers have been sceptical of the traditional banking system. The rise of alternative finance options, such as peer-to-peer lending and shadow banks, speaks volumes of the public’s desire to explore other routes for their financial needs.

      Negative interest rates are unlikely to change this perception. Charging people to hold money in an account will not go down well, and will encourage them to look towards other options for their money if they have not already. Although this has not trickled down to the consumer level yet, it could be argued that, if negative rates persist, it is merely a matter of time.

      When Mario Draghi, president of the European Central Bank (ECB), made the infamous pledge in 2012 to do “whatever it takes” to save Europe’s struggling banking system, few at the time would have guessed that this would include interest rates below zero, especially in the context of its quantitative easing (QE) programme. But in June 2011 the ECB was the first major central bank to dip into negative territory, setting the base rate at negative 0.1 per cent. Since then the rate has sunk further, reaching negative 0.2 per cent in September last year.

      The ECB is not alone in its use of negative interest rates – other European countries who are not members of the EU were left with little choice but to cut rates further after the ECB went ahead with the controversial policy. Had they not, it would have increased the risk that investors would pile into alternative European currencies in order to avoid the negative rates. This could have caused the currencies to artificially appreciate rapidly, making exports less competitive.

      Sweden has pursed a combination of increasing bond buying and negative interest rates. In an effort to protect the krone’s peg to the euro, Denmark implemented negative rates to reflect the ECB’s policy, and for the first time since the 1970s, Switzerland has also ventured into negative territory.

      Some point to negative rates as a prudent policy from central banks to deal with a unique economic climate. Others flag it as a sign of desperation.

      PAGE 1 OF 5