Central Banks Embrace Negative Rates That Economists Scorn

Do Negative Interest Rates Actually Work?
  • Effectiveness of sub-zero rates at ECB and BOJ doubted
  • SNB will go lowest; only Denmark has achieved its objective

Haruhiko Kuroda and Mario Draghi may be among the few economists who still think negative interest rates are a good idea.

The Bank of Japan governor’s decision last month to charge banks on some excess reserves, a year and a half after his counterpart at the European Central Bank took a similar path, means that a quarter of the world economy is now in the sub-zero club.

Yet just 27 percent of respondents in a Bloomberg survey say negative rates will help Kuroda reach his goal of boosting feeble inflation, and only 42 percent say the policy is succeeding in the euro area. While the strategy has shown it can weaken currencies -- one channel for spurring consumer prices -- the discussion over how long that can last and the likelihood of unintended consequences is getting louder.

“Since more and more central banks are applying negative rates, this instrument is becoming less effective,” said Kristian Toedtmann, senior economist at DekaBank in Frankfurt. “All these currencies can’t devalue at the same time. The result may be an excessive use of negative rates with harmful side effects.”

Capital Shield

What started in 2012 as a consequence of Denmark’s fight to defend its currency peg to the euro has now become a mainstream policy pillar, mulled even by the U.S. Federal Reserve. The survey of 63 economists shows that while some say negative rates helped avert even worse downturns, the strategy is only really appropriate for small economies shielding themselves against speculative capital flows.

Ninety percent of respondents said the Danish Nationalbank is on the right track and 70 percent approved of the Swiss National Bank’s use of the measure. Both are protecting their currencies. Less convincing was Sweden’s Riksbank, which lowered the repo rate to minus 0.5 percent last week to bolster inflation, and which had the support of just 41 percent of economists.

Even so, the skepticism doesn’t seem to be deterring monetary officials in Tokyo, Frankfurt or Stockholm.

Further Cuts

In the euro area, overnight index swaps show that investors expect the deposit rate, now at minus 0.3 percent, to fall a further 20 basis points by mid year. Draghi has indicated the next step could come as soon as March. In Japan, Kuroda told parliament on Friday that negative rates will help boost the economy by stimulating investment in capital and housing. The Riksbank said last week that it has the scope to reduce rates further, though economists in the survey said it’s probably reached the floor.

Euro-area inflation was 0.4 percent in January and the ECB says it may turn negative in coming months. Japanese consumer prices probably stagnated last month. Sweden’s rate was 0.8 percent. The central banks for all those economies have inflation goals of around 2 percent.

The standard central-banker defense to criticism of apparently inert stimulus is the counterfactual -- things would have been even worse without it. That’s a sentiment echoed by some respondents in the survey.

The ECB’s policy “has prevented a larger decline in inflation and has helped to push lending rates to the economy lower,” said Philippe Gudin, chief European economist at Barclays Plc.

Currency Distortion

When it comes to actually boosting inflation, not to mention wages and economic growth, negative rates can’t do much and they distort foreign-exchange markets, according to Elwin de Groot, an economist at Rabobank in Utrecht, the Netherlands. In a sign that currency traders have started to rebuff both the ECB and the BOJ’s easing efforts, the euro and yen have risen against the dollar this year.

ECB policy makers acknowledged the issue at their Jan. 21 meeting in Frankfurt. An account of the session published this week stated that while the exchange rate’s role in transmitting monetary policy is still important, the channel has weakened.

“Negative rates may have started to backfire,” said de Groot. “For small central banks, negative rates can be an effective tool to steer their currencies. When major central banks cut rates further into negative territory, they simply raise the global currency war to a higher level.”

‘Serious Rethink’

Economists foresee that war continuing for a while yet, with a majority of respondents predicting negative rates will be in place at the ECB and Riksbank until at least the first quarter of 2018 and at the BOJ until at least the end of that year.

Switzerland, long seen as a haven for investors from the euro area which surrounds it, will have to plumb the greatest depths, cutting from the current minus 0.75 percent to minus 1 percent, the survey indicated. The SNB was forced to abandon its currency cap in 2015 under pressure from the ECB’s oncoming quantitative easing.

“Policy makers have slashed interest rates to zero or lower in some cases and pumped up markets with trillions of dollars of stimulus, yet inflation and bond yields have stubbornly refused to rise,” said Alan McQuaid, chief economist at Merrion Capital Group Ltd. in Dublin. “The bottom line is that negative interest rates are not the answer to the world’s economic problems and central bankers need to have a serious rethink -- and soon.”

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