MARKET NEWS

If pricing in the money markets is anything to go by, the Bank of England will introduce negative rates in Britain for the first time next year.

It has been no secret in recent months that Threadneedle Street is reviewing how sub-zero rates might be implemented, although Andrew Bailey, the Bank’s governor, has been at pains to emphasise that its work implies nothing about whether policymakers will use the policy tool.

The Bank last week asked commercial lenders for information about whether their systems could cope with negative rates, spurring yet further speculation that it was moving closer to cutting rates below zero.

By charging firms to keep deposits at central banks, the theory behind negative rates is that it encourages commercial banks to lend rather than hoard cash, thereby stimulating the economy.

The Bank will be looking to other countries where negative rates have been deployed to gauge whether they work in practice.

SWEDEN

The economy

Economists are still divided over Sweden’s experiment with negative interest rates. In an effort to combat below-target inflation, the Riksbank became the first central bank to introduce sub-zero rates in 2009 when it cut the deposit rate for commercial bank holdings into negative territory. Its main rate went below zero in 2015 for almost five years.

Inflation returned to the 2 per cent target in 2017 but this is not necessarily an indicator of success. Some argue that the pick-up in inflation had more to do with the general European business cycle than domestic policy on negative interest rates.

Price growth in the euro area increased from -0.3 per cent in 2015 to 2 per cent by the middle of 2018 and then to 1.4 per cent at the beginning of the year. This was closely mirrored in Sweden.

The negative rates policy has been blamed for exacerbating social inequalities. Cheap borrowing had already fuelled property prices relative to incomes, a trend that continued under negative rates. Household debt also reached record levels, forcing policymakers to introduce credit controls that had a disproportionate impact on younger and poorer households.

Fredrik NG Andersson, a professor at the Lund School of Economics and Management, said: “While the impact of the negative rates on the domestic inflation rate is small (probably negligible), the effects of negative rates on the housing market and on household debt levels are large. Imbalances that had already begun to materialise before the global crisis have worsened.”

Banks

Negative rates are most painful for banks that are reliant on big deposits because it is difficult for them to meaningfully pass on the cost by levying sub-zero rates on customers’ savings, without pushing people into withdrawing their cash.

As a result, banks have tended to target only corporate deposits and those of wealthy customers in countries where rates have gone below zero.

Swedish banks were able to cope with five years of negative rates partly because they mainly fund themselves via the markets, especially for mortgages. They raise finance by issuing covered bonds, which can carry negative rates.

When Sweden’s central bank took rates below negative in 2015, commercial lenders responded by lifting mortgage prices for customers. The price rises, combined with the banks’ falling funding costs, meant their mortgage margins jumped.

JAPAN 

The economy

The Bank of Japan adopted negative interest rates in 2016 to boost spending and drive down the yen, which was hurting the export-reliant economy. Instead of falling, the Japanese yen rose by 15 per cent against the dollar in the first nine months of 2016.

The exchange rate later stabilised but the yen’s status as a safe haven currency during times of political uncertainty means that demand for the currency has been robust over the past few years. As with most other countries that have experimented with negative rates, it is difficult to disentangle the impact of the policy from broader economic forces. Negative rates did not lead to a substantial pick-up in inflation or growth but structural deflation did not set in either.

Business investment has been robust but this cannot be purely attributed to the availability of ultra-cheap loans. Some of the investments made by businesses would have taken place anyway: such as those linked to the Tokyo Olympics and investment in labour-saving technologies to cope with Japan’s ageing population.

Households

Negative interest rates did not trigger a wave of consumer spending and the savings rate remained broadly stable. Japan, which is already a more cash-based society than other advanced nations, also experienced an increase in demand for safety deposit boxes.

Weak growth and low inflation led to wage stagnation in Japan as businesses were unable to eke out pay rises for their employees. The economic reality can partly be explained by structural factors, predominantly Japan’s ageing population, combined with weak flows of inward migration.

It is widely accepted that fewer people of working age means slower growth and a smaller economy. The impact of monetary policy on consumption is thought to be much weaker in ageing countries with low labour participation.

Banks

Even before the Bank of Japan turned to negative rates, the country’s commercial lenders had for decades been grappling with rock-bottom rates.

Despite the pressure on profits, firms have resisted charging customers fees for bank accounts after rates went below zero. Instead, the banks, particularly the country’s biggest lenders, have sought to escape the punishing environment by stepping up their lending abroad in an effort to boost profits.

This has meant that the sector’s foreign investments have surged to record highs, with overseas credit standing at 4.7 trillion yen at the end of March.

Yet there are concerns that this has led Japanese banks into increasingly risky areas as they scramble to offset margins squeezed by negative rates. Research by the Bank of Japan and the country’s banking watchdog released in June showed that Japanese groups together owned nearly a fifth of the world’s $750 billion market for collateralised loan obligations. These are securities that are backed by packages of debt, usually loans to firms with riskier junk ratings.

There are worries that the banks could be hit if there is a wave of defaults.

DENMARK

The economy

Denmark has had a negative benchmark rate for the best part of eight years, longer than any other country. The policy was introduced after the financial crisis to weaken the krone, which is pegged against the euro. The implications for the economy have been far less tumultuous than expected. Negative interest rates have underpinned private consumption, job creation and wage growth. Exports have remained resilient.

Research by the country’s central bank, Danmarks Nationalbank, suggests that the policy’s transmission into the real economy has yielded positive results. When non-financial firms were charged negative rates on their deposits, they increased both investment and employment in response.

Households

Banks are no longer shielding ordinary consumers from negative interest rates. Seven years after Danish rates went under zero, commercial lenders in the country finally began charging wealthy customers to deposit their money.

Jyske Bank was the first when it said last August that it would levy a negative rate on customers with more than 7.5 million kroner (just under £1 million) and others followed suit. Jyske has since lowered the deposit threshold on which it charges a negative rate to 250,000 kroner (£30,000).

At the same time, some homeowners are now on mortgage deals that have negative rates, which means they are paying back less than they originally borrowed, although this is offset by banks’ arrangement fees. Household debt remains above 270 per cent of disposable income, the highest level among advanced economies.

Banks

Danish banks have been able to withstand the hit from prolonged negative rates to some extent because of improving loan losses and a surge in households taking advantage of cheap mortgages.

Charging sub-zero rates on customers with bigger deposits has also helped lenders to offset some of the costs they face when they store excess money at the country’s central bank.

Yet even so, the damage inflicted on their underlying business models from below-zero rates has still been painful.

Jyske said at its annual results in February that negative rates contributed to a 650 million kroner fall in its net interest income over the previous five years, even though lending had risen by 100 billion kroner during that period.