How low can you go?
On July 8th, the Riksbank Ã¢â‚¬â€œ SwedenÃ¢â‚¬â„¢s central bank Ã¢â‚¬â€œ changed its deposit rate to negative 0.25 percent thereby becoming the first central bank to implement a negative interest rate policy.* Despite the boldness of this policy move, the news seemed to elude mainstream notice, but you can be sure that other central banks were playing close attention. Perhaps some commercial bankers as well.
Over the past eighteen months or so, central banks have consistently lowered lending rates to deal with the ongoing recession. These actions have brought rates closer and closer to zero, and prevailing thought has long been that interest rate policy was constrained by a zero lower bound. Central Banks have fastidiously avoided negative interest rates and experts, including Ben Bernanke who co-authored a paper entitled Conducting Monetary Policy at Very Low Short-Term Interest Rates, argued that negative interest rates are not an option. This argument is usually based on the opinion that should interest rates fell into negative territory, consumers would remove money from the economy Ã¢â‚¬â€œ presumably by stuffing cash into a mattress Ã¢â‚¬â€œ rather than pay to keep it on deposit with a financial institution.
Will these beliefs change now that Sweden has dispelled the notion that you canÃ¢â‚¬â„¢t take interest rates negative? Or has it? In actuality, Sweden has left its most important rate Ã¢â‚¬â€œ the Repo Rate which actually serves as the benchmark for commercial lending Ã¢â‚¬â€œ at a positive 0.25 percent. By changing only the deposit rate, the net effect is that commercial bank deposits held at the Riksbank will be charged, rather than receive, interest. Obviously, the primary objective is to goad banks into lending money by making it too costly for them to simply park money in cash accounts. This is quite different from a negative lending rate but it does send a very strong message nonetheless.
Now that the seal has been broken on sub-zero interest rates, will others consider this? It really is hard to imagine that the Federal Reserve could opt for such a drastic policy move Ã¢â‚¬â€œ especially given BernankeÃ¢â‚¬â„¢s public stance against negative interest rates Ã¢â‚¬â€œ but all bets could be off if the economy takes another dive as some suggest is possible.
Meanwhile, rumors swirl about the Bank of England as a possible candidate to also go negative, but I donÃ¢â‚¬â„¢t see this as likely. Unlike Sweden, the Bank of England has engaged in substantial quantitative easing to increase cash levels held by the countryÃ¢â‚¬â„¢s commercial banks. The Bank of England did this by purchasing assets held by the commercial banks, much of which was deemed too Ã¢â‚¬Å“toxicÃ¢â‚¬Â for private buyers. This little buying spree cleaned up bank balance sheets supplying them with new, clean money that the government now fully expects to be made available for immediate lending to boost spending. Both England and Sweden had the same goal of increasing bank lending; England just went with the Ã¢â‚¬Å“carrotÃ¢â‚¬Â approach while Sweden opted for the Ã¢â‚¬Å“stickÃ¢â‚¬Â.
In SwedenÃ¢â‚¬â„¢s case, the Riksbank obviously believed that Swedish banks were already sufficiently-capitalized but just needed a little encouragement to get that money flowing. Having to pay interest for cash sitting in deposit accounts could provide that encouragement.
Still, British bankers have little reason to fell smug and would do well to take heed; now that the Bank of England has fumigated your balance sheets, you had best make with the lending. The British taxpayer has endured much lately and has taken on additional debt to fund the quantitative easing program, so being stingy with lending could force the government to take more direct action. The Monetary Policy Committee is scheduled to meet next week and with the pound still struggling and the bank rate already at 0.5 percent, little interest rate headroom remains. If the sense is that the banks are hoarding cash, public pressure could force the government to follow SwedenÃ¢â‚¬â„¢s lead.
* In 1971, the Bank of Switzerland did impose a negative rate for non-Swiss investors buying the Swiss franc. This was a move designed to ease the appreciation of the currency and did not apply to Swiss citizens or businesses.
About the Author
As a content writer specializing in the financial sector, Scott Boyd has produced educational materials and conducted market analysis for several of CanadaÃ¢â‚¬â„¢s leading financial institutions. Scott now contributes articles to OANDA’s Forex blog and is keenly interested in the factors affecting global currency prices.