Negative central bank interest rates now herald new danger for the world
The world's tentative experiment with negative interest rates got off to an unremarkable start.
Sweden's Riksbank - the world's oldest central bank - became the first major monetary authority to cross the rubicon and take its main policy rate into the red exactly a year ago to the month (see map above).
The Riksbank’s move followed the likes of Switzerland and Denmark, who had turned negative in a bid to stimulate flagging inflation and halt the punishing appreciation of their currencies.
But the introduction of sub-zero rates caused no immediate panic that central bankers were "losing control".
Neither did they seem to produce deleterious economic effects in their host countries, as savers continued to keep their money deposited in banks rather than fleeing for the safety of cash. Commercial lenders, meanwhile, adjusted their business models to help maintain profitability.
• How Sweden's negative rates turned economics on its head
In September, Andy Haldane, chief economist at the Bank of England, joined a chorus of influential thinkers in positing that negative rates could be necessary to protect the UK and the other advanced economies from the next global recession.
The "new abnormal"
But recessionary fears have crept up on the world much faster than the likes of Mr Haldane may have anticipated.
Global markets have crashed into bear market territory. A cocktail of fears, including the collapsing price of oil, the creaking health of the world's biggest banks and China’s competence in managing its economic slowdown, have ignited fears that investor panic may lead the world into a new downturn.
Bank shares have been in the eye of the selling storm, concentrating minds on just what negative interest rates mean for the financial system.
Jitters were set off by the Bank of Japan's shock decision to join the negative rate club at the end of January. One year into the negative rates experiment, it seemed monetary authorities were getting desperate in their attempts to stimulate growth and inflation with their limited policy tools (see map above).
Like its counterparts in northern Europe, Japan's sub-zero rates were intended to drive down the value of its currency, the yen. It didn't work.
The yen has now risen by 10pc against the US dollar since the Bank of Japan's negative interest rate decision on January 30.
Sweden soon followed suit in the competitive devaluation cycle, slashing its already negative repo rate to -0.5pc to generate inflation by weakening the value of the krona.
With the ECB expected to head further into negative territory next month, the world has entered a "new abnormal" of negative rates, says Scott Mather at Pimco, the world's biggest bond fund.
Taxing the banking system
One of the unintended consequences of global central banks' race to the bottom (which seemingly has no bottom) is that negative interest rates act as a tax on the banking system.
By penalising commercial lenders for parking their reserves at the central bank, it erodes the profit margin they make on charging already low interest rates while raising the cost of capital.
So far, "banks seem unable or unwilling to pass negative deposit rates to their retail customers, leaving them with few options to offset costs", note analysts at JP Morgan.
They also highlight that, should banks start imposing higher lending costs on their customers, this would have the reverse effect of easy monetary policy, crimping credit creation and tightening financial conditions.
Time for fiscal dominance
All of this begs the question of whether the world has hit the limits of what monetary policy can achieve, as the distortions produced by sub-zero rates overwhelm its stimulatory benefits.
The current global recovery has been one of the most deflationary in modern times. Over the last six-and-a-half years, the nominal GDP of the advanced world - or the total cash value of their economies - has grown by just 11pc, according to Bank of America Merrill Lynch.
Meanwhile, more than $8 trillon of high grade sovereign debt is trading at a negative yield.
Distortions such as this have led prominent monetary policymakers to dub the move into negative interest rates a "gigantic fiscal policy failure".
Eight years on the from the financial crisis, central banks have done all the heavy lifting to get the world out of its low growth morass. Monetary policymakers have cut interest rates 637 times and purchased $12.3 trillion (£8.5 trillion) of assets since March 2008.
Mario Draghi, president of the European Central Bank, bemoans that his institution has provided the sole source of stimulus to the eurozone over the last six years. He renewed his calls for governments to finance mass public investment schemes and cut tax burdens to reflate their economies this week.
So although negative interest rates may herald new danger for financial markets, they could well be the catalyst jolting politicians and governments into finally making use of powerful fiscal policy tools to rescue the world from the grips of another slump.
( Source )