The Frontier of Negative Rates23/03/17
We’ve discussed the trend of developed countries pursuing record-low interest rates in the past, and that trend continued into late 2016 despite modest economic growth over the year. Numerous countries are still holding cash rates low and steady, and most central banks have given little indication of whether they will raise them over 2017. In some countries, negative interest rates have been pursued and praised as a saviour of countries struggling to achieve growth, however there have been few countries to achieve this goal as of yet.
The Reserve Bank of Australia has so far continued to keep the cash rate on hold at a low 1.5% throughout 2017, with inflation remaining below the RBA target range, and no rise is expected until at least mid-year. Conversely, the US Federal Reserve rose interest rates at the end of 2016 amid moderate economic growth and a positive outlook overall, though the rates are still historically low. Some have critiqued this kind of low interest rate policy as being ineffective, after all, the US has had record low interest rates since as far back as 2008, and their economic growth has still been sluggish at best up until recently.
From Denmark, however, there is some suggestion of a low-rates success story. Denmark has had negative rates since around 2012, but has continued to experience wage growth, increased employment and an increase in the amount of Danes paying principle on their home loans rather than interest only payments. The concept behind negative interest rates is that cash will be loaned out and invested rather than saved, and that has proved somewhat true in that Danes have record savings and investments at the moment.
One reason for the success may be that, for now, Danish banks have generally not passed negative interest rates on to customers. While this appears to have helped prevent the cash rates from directly impacting most Danes, there is nothing to prevent banks from passing on negative interest rates or fees to customers in the future. In Australia, several banks have opted to not pass on rate cuts at all, given the lack of profitability in doing so.
The long term issue for negative interest rates is that policy makers are cautious of raising rates in the future. The low cost of capital that has existed for a number of years is likely to have created asset bubbles across the market, which could leave the market susceptible to any sudden shifts in rates.
Denmark has historically had one of the highest personal debt to income levels of any developed country, and amidst a booming housing market, cracks may start to form in the negative interest rate policy held by the Danish central bank. In particular, a significant portion of Danish wealth is held in housing, much like in Australia, and therefore any rise in cash rates could see the pressure of home loans damage the market, resulting in a significant decrease in net wealth of Danes.
Despite some lauding the negative interest rate policy as the key to the success of the Danish economy over the last few years while much of Europe struggles, it could be argued that Denmark is succeeding regardless of the negative interest rates, but not because of them. One of the larger risks raised about negative cash rates is that cash itself has no interest rate, that is to say, if negative interest rates were to be passed on to consumers, it would be better in most cases to withdraw the cash from the bank and hold it yourself. While this is unlikely to occur in Denmark as banks haven’t passed on the negative rates, bank-runs have occurred in other European countries such as Greece.
Although some have commended negative interest rate policy as the foundation for prosperity in Denmark, one must really ask whether this outlying success story gives correlation to negative interest rates and economic growth, as no other country has experienced this effect from negative rates. We must also look to the future and consider the impact that rising rates will have in the Danish asset market, and whether individuals are over-leveraged in the market. Given that this kind of monetary policy is still fresh ground and the long term effects have not been studied, only time will tell what will happen.