Negative Interest Rates
12th March 2020
With the surprise 0.5% rate cut yesterday from the Bank of England reducing interest rates once again to a historic low of 0.25% we thought it would be particularly relevant to talk about negative interest rates in this month’s blog.
What are negative interest rates?
Negative interest rates in its simplest term means borrowers are being paid to borrow someone else’s money (BBC, 2016). The negative interest rate policy works whereby financial institutions are required to pay interest for leaving excess reserves with the central bank. This is any surplus cash that is beyond the regulations at which the bank can keep on hand. The European Central Bank introduced negative interest rates in 2014, lowering rates to -0.1% to stimulate the economy (Reuters, 2019).
Why do banks use negative interest rates and how does it affect consumers?
The central bank of the nation decides interest rates, according to government policy. When banks use negative interest rates, it makes it more expensive for consumers to save their money with their bank. This discourages savers to save into savings accounts and instead promotes spending instead. In addition, the fact that it costs less to borrow and borrowing is encouraged by the scheme, this gives more disposable income for consumers to spend. This was the main objective following the 2008 financial crash, where the economy was in a rut and spending was very low amidst financial breakdowns and lack of disposable income as well as uncertainty. Encouraging spending promotes economic growth as the businesses receiving consumer expenditure experience heightened revenue and therefore economic growth. (Reuters, 2019).
With the introduction of negative interest rates, many consumers will face a change in their banking activity as charges will now appear for the use of the account they hold with the bank or building society. It can be harmful to banks more so than the consumer because fewer people will continue to save money with the bank due to the adverse change, therefore the bank loses the money that consumers would have to pay. Additionally, as mortgage interest payments would be lower, the bank would gain less revenue from the borrower as a result (The Guardian, 2019).
What other countries have utilised negative interest rates?
There are 5 central banks that have started using negative interest rates. This includes the European Central Bank which affects most of the banks in Europe including those in France and Germany. Other countries that employ negative interest rates include Japan, Switzerland and Sweden (Business Insider, 2019).
Denmark was the first country to brave the changes by introducing negative interest rate mortgages paying borrowers 0.5% a year. Danish banks Jyske and Nordea introduced negative rate interest mortgage policies with ten, twenty and thirty year terms at respective rates of -0.5%, 0% and 0.5%. Effectively turning banks upside down reversing their methods in which they generate income.
What happened with Sweden?
Sweden were the pioneers of the negative interest rate experiment. It was the first country to introduce negative interest rates and they were deployed by Sweden’s central bank, Sveriges Riksbank. They set the country’s main interest rate to -0.25% (Randow & Takeo, 2019).
In December 2019, Sweden stopped the negative interest rate experiment because of concerns regarding collateral damage and unintended consequences (El-Erian, 2019). There were publicly raised concerns about the persistent negative yields and how that adversely influences the behaviour of households and companies.
We collectively agree that using negative interest rates is a good thing for the economy, but only to a certain extent and should only be used at the right time when the economy needs stimulation. However, it can be harmful to banks as they might not gain as much revenue and it can be harmful to consumers when they run out of money to spend and at that point, it would be more difficult and expensive to save their remaining funds so it can have consequences.
Strauss, D. (2019) Trump has ramped up calls for negative interest rates. Here’s what they are and why they matter. Available at: https://markets.businessinsider.com/news/stocks/negative-interest-rates-explained-what-they-are-why-they-matter-2019-8-1028516867 [Accessed 28th February 2020]
Elrian, M.A. (2019) Sweden Says Enough Is Enough on Negative Interest Rates. Available at: https://www.bloomberg.com/opinion/articles/2019-12-19/sweden-s-riksbank-has-had-enough-of-negative-interest-rates [Accessed 28th February 2020]
BBC (2016). Why use negative interest rates?. [Online] Available at: https://www.bbc.co.uk/news/business-32284393 [Accessed 28 February 2020].
Randow, J. & Takeo, Y., (2019). Negative Interest Rates. [Online] Available at: https://www.bloomberg.com/quicktake/negative-interest-rates [Accessed 28 February 2020].
REUTERS (2019). Explainers: How does negative interest rates policy work?. [Online] Available at: https://www.reuters.com/article/us-ecb-policy-rates-explainer/explainer-how-does-negative-interest-rates-policy-work-idUSKCN1VY1D2 [Accessed 28 Febuary 2020].
The Guardian, 2019. Danish bank launches world’s first negative interest rate mortgage. [Online] Available at: https://www.theguardian.com/money/2019/aug/13/danish-bank-launches-worlds-first-negative-interest-rate-mortgage [Accessed 28 February 2020].