The Experiment With Negative Interest Rates

Dan Kutzke By | On March 24, 2016

When governments wish to create economic growth in their economies, it is common for them to lower central bank interest rates.  This will encourage businesses to expand and individuals to buy houses.  It can really work to help ward off recessions and promote economic growth.

But what do you do if interest rates are almost at, or already at zero?  Japan, Sweden, Denmark and Switzerland have decided to push their interest rates below zero- into negative territory!  The European Central Bank (ECB) followed that up with lowering the amount that they charge banks for long term cash to minus .40%, if they actually make loans with the money.  Let me try to explain the upside down world of negative rates.

Think about your current mortgage loan.  You make a payment of principal, plus interest each month.  With negative rates, you would subtract the interest from the principal payment each month!  In Spain, where variable rate mortgages are common, some mortgage payments have fallen by 40%, making them lower than rent payments.  Great for borrowers, right?

But it is causing fear at banks, causing bank stocks to plummet and making depositors wonder how long they will continue to receive interest on their savings accounts.  Banks cannot afford to credit interest on checking and savings accounts, while paying interest on loans at the same time, on the same money.  Customers will begin to withdraw cash and stash it in their mattresses, if they begin to fear bank failures.  Banks have not yet made the move to charge customers for deposits, but cannot continue down this road for long.  In the meantime, the moves by the ECB to increase their monthly bond purchases (their version of quantitative easing) have worked to lower interest on both government and corporate bonds, squeezing bank profits even further.

When the Bank of Japan (BoJ) tried the same tactics this month, it backfired, sending the value of their currency, the yen, sharply higher, hurting their economy.  In similar fashion to Europeans, the people of Japan have actually begun to purchase home safes to hoard cash, in the event banks charge interest for deposits. The unconventional move by the BoJ has been seen as a sign of desperation, to try to move Japan out of their economic funk.  Real wages have fallen, the Japanese stock market is trending lower and inflation has leveled off, each indicating additional action will be taken by the BoJ to lower rates further or begin their own bond purchase program.

How does it affect us here in the US?  There is no expectation of negative interest rates here, but our rates have not risen much either.  The Fed has decided not to raise short term rates at their March meeting, but it is expected to raise rates twice later this year.  Our economy shows no sign of recession, so there is no urgency of the Fed to stimulate at this time.

Time will tell if this experiment with negative interest rates will lead to global growth, or if it will just go down as an interesting experiment with questionable results.  It will be a good one for the historians!

 

Dan Kutzke is a financial advisor located at Pratt, Kutzke & Associates, LLP, 959 34th Avenue NW, Rochester, MN 55901. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 507-281-6650 or at dan@pkallp.com.