Posted by Louisa Heath on March 15th, 2016.
If you’ve been paying close attention to news on the foreign exchange front in recent weeks there’s a high chance you’ve heard the term ‘negative interest rates’ being batted around. It’s a term that can sound more than a little worrying, evoking the image of your bank balance slowly being chipped away rather than accumulating worth as it commonly would. Scare mongering might have you reaching for an empty mattress in which to start stuffing your business’ savings but in reality the picture is a lot less like a disaster movie and could, in fact, prove beneficial in the long term.
In the wake of the global financial crisis of 2008 a number of the major central banks slashed their interest rates to record lows, aiming to stabilise markets and support recovery in domestic economies. While the Bank of England (BoE) lowered the headline rate to 0.50% and the Federal Reserve dipped to 0.25% the Riksbank took the more unprecedented step of going ‘sub-zero’.
This was initially seen as a short-term measure, meant to counteract market volatility and spiralling inflation, although eight years later the Riksbank remains in negative territory and has been joined by the Danish National Bank, Swiss National Bank (SNB), the European Central Bank (ECB) and the Bank of Japan (BoJ). Largely this is due to the global economy taking a rather slower pace towards recovery than the financial institutions had originally envisioned. As a result ultra-low rates have effectively become the new normal, with many policymakers reluctant to hike lest they damage the still fragile nature of economic growth.
However, this period of unusually accommodative monetary policy has ultimately created a new problem for the central banks, leaving them with significantly less ammunition with which to tackle any new threats to the global economy. Of particular concern has been the slowing of the Chinese economy – with the nation previously being a key driver of the global recovery – which has raised questions of a return to recession. And ultimately the longer term impact of proliferating negative interest rates on the global economy has yet to be determined.
What this all means in real terms is that these central banks charge those who park money with them, penalising those who would choose to stockpile funds rather than lending and reinvesting into the economy. As a result the move to negative rates is designed to increase the incentive for banks to lend to consumers, fostering greater growth, as well as making their respective currencies less attractive to investors.
So far banks have been reluctant to pass this additional cost onto their own customers which, although positive for the customer, has led to concerns over both profitability and sustainability. In part it was the march towards deeper negative rates in the Eurozone that caused market turbulence earlier in the year, as banking shares were hammered in response to these fears.
For those of us in the UK it doesn’t seem entirely likely that we will have to see our central bank move into negative territory, with assurances from BoE Governor Mark Carney indicating that while rates might still be cut further they will not go below 0%. However, that doesn’t mean those dealing internationally won’t feel the impact. One of the major impacts of negative interest rates tends to be on the value of the corresponding currency, with both the ECB and BoJ employing negative rates at least partly on the rationale of weakening their respective currencies.
Consequently, those trading with any country with negative rates may expect to find that the exchange rate becomes somewhat more favourable as the native currency depreciates in response. This can be a great boost to business, although those looking to attract trade from one of the affected nations may find themselves in a slightly less favourable position as the appeal of Pound denominated goods becomes reduced.
Possibly the most serious risk from negative rates, however, is in their larger impact on the macro economy. With a number of the world’s major central banks already in negative territory there are concerns that the impact of any potential recession could ultimately be worse, simply by virtue of all of the previously used measures having already been exhausted, and in some cases having never gone away.
There are also concerns of the impact that might stem from a detrimental race to the bottom, with European currencies in particular exposed to the threat of a currency war. Given the close trading proximity of European nations, when the ECB opts to loosen monetary policy this is more likely to compel other central banks in the area to lower rates in response, which in turn encourages the ECB lower in order to remain competitive. This risks creating a negative feedback loop, with an excess of negative interest rates likely to only decrease their effectiveness as a constructive tool of monetary policy.
At the end of the day, negative interest rates remain something of an uncertain territory for central banks, so it is rather difficult to say if they will ultimately have the cataclysmic effect on the global economy – or smaller businesses – that some have suggested. And while the monetary policy decisions of central banks such as the BoE and ECB will have a tangible impact upon exchange rates this does not change the naturally volatile nature of currency movement. If you’re concerned about the impact negative exchange rates could have on your business do further research into the subject and consult an independent financial advisor about your options.
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