Racing to the Bottom or Money For Nothing*

Despite the fact that news headlines for the last few weeks were dominated by the lead-up to the U.S. election and the election night itself, there were other newsworthy events going on in the world. For forex traders, it has been a full-time job keeping track of interest rates adjustments as central banks attempt to out-do each other in what some are now suggesting could be the prelude to a period of zero percent interest rates in the world’s major economies. Oh boy, free money for everyone!

As the US election was – mercifully – reaching its conclusion, most of the Group of Seven nations were busy reducing key lending rates in order to stimulate economies succumbing to the current economic crisis. Even the Reserve Bank of Australia with the highest (at the time) interest rates in the G7 got in on the act with two rate cuts inside of a single month. But this was just the beginning.

On October 21st, the Bank of Canada lowered its lending rate by 25 basis points to 2.5 percent and the US Federal Reserve followed suite one week later, shaving half a percent off the Federal Funds Rate reducing it to an even 1.0 percent. Two days later, the Bank of Japan took the lead in the race to zero percent by dropping its overnight lending rate to an awkward 0.3 percent, down from 0.5 percent.

Then, on November 6th, came the biggest surprise as the Bank of England cut a full percent and a half from its lending rate, reducing the benchmark overnight rate to 3.0 percent – its lowest level since 1955 and the largest single cut every offered by the Monetary Policy Committee. By comparison, the European Central Bank was almost shamed into delivering a half percent cut to 3.75 percent on the same day.

Interest Rate Cuts to Spur the Economy

In order to kick-start a sagging economy using interest rate cuts, interest rates must be at even or below inflation. For those keeping score at home, and assuming a typical inflation rate of 2.5 percent, three of the G7 countries now have an interest rate at or below this level; unfortunately, we aren’t seeing much in the way of typical inflation right now. Most of the G7 is actually verging on deflation which means that a lending rate of 3.0 percent is still too high given the conditions.

So, if inflation is basically at or even below zero for a given country, does that mean that interest rates have to match that level in order to have the desired effect? While I don’t think anyone will actually pay you to borrow their money, it looks quite likely that some jurisdictions will be willing to give you their money for nothing if that’s what it takes to get spending on the rise again.

* with apologies to Dire Straits