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Negative Policy Rates Seem To Be Working For Now: Capital Economics

The introduction of negative policy rates by four European central banks over the past year has helped to trim longer-term interest rates and to stem the upward pressure on some currencies, notes Capital Economics.

Respected macro research firm, Capital Economics in its June 25, 2015 report titled: “Are negative policy rates here to stay?” notes despite looming Fed tightening, the global easing cycle is not over yet.

Drop in average interest rates

The report points out that during the past twelve months, the ECB, the Swiss National Bank, the Danish National Bank and the Swedish Riksbank have all cut policy rates below zero.

Summary of unconventional monetary policy Negative Policy Rates

Interbank interest rates in the euro-zone have followed deposit rates into negative territory. The policy rates cuts have also pruned expectations for the path of short-term interest rates, as revealed by overnight index swap futures:

ECB deposit rate Negative Policy Rates

The report notes in the twelve months since negative rates were imposed, average interest rates faced by firms in the euro-zone have dropped from 3.8% to 2.9%:

Drop in interest rates Negative Policy Rates

Taking a closer look at the impact on currencies, tthe euro depreciated both before and after the ECB introduced negative rates, but it dropped much more sharply when the ECB announced an expanded asset purchase programme for government bonds.

Trade weighted Euro Negative Policy Rates

The negative rates have played only a small role in the depreciation of the euro over the past year. Interestingly, the CE report highlights that introduction of negative rates in Sweden and Switzerland has not stopped their currencies from appreciating.

Negative policy rates: Concerns have been allayed

Turning its focus to concerns over negative interest rates, the report highlights that these concerns have so far proved unfounded. The authors argue their view point with reference to three scenarios.

First, there was concern investors would shift their deposits out of the central bank and into cash. However, commercial banks have continued to park their reserves at the central bank, even when this has carried a negative interest rate. As can be deduced from the following graph, Denmark has had a negative deposit rate for most of the past three years, but this has had no discernable impact on the amount of currency in circulation:

Denmark deposit rate Negative Policy Rates

Secondly, there were concerns that negative interest rates may squeeze commercial banks’ profitability, which in turn could curb credit supply. However, the report authors argue that as demonstrated by Denmark, central banks can trim the share of reserves that are subject to a negative interest rate in order to reduce the impact on profitability.

Allaying the third concern that negative nominal rates would result in a minefield of legal and tax disputes, the report argues that the negative rates haven’t proved a major road block to date.

The Capital Economics report argues that the four central banks which have already imposed negative rates will leave rates below zero for longer than most expect. Furthermore, the authors anticipate the Swedish Riksbank and Swiss National Bank to trim rates even further in the coming months:

Overnight repo rate- Sweden Negative Policy Rates

Outside Europe, Japan is perhaps the most obvious candidate for negative policy rates. The report authors anticipate further policy easing to come in three of the four BRIC economies viz.: China, India and Russia, while central banks elsewhere should be able to leave policy on hold:

Central bank policy rates Negative Policy Rates

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