Implementing negative interest rates was once a daring experiment in monetary policy that would have shocked many an economist, but it is now a widely accepted tool in a central bank's arsenal.

A common investor view is that negative interest rates are now a long-term, rather than a short-term, solution in a new world order in which investors are so dissatisfied with financial markets that they will pay bond issuers to park their money in fixed-income instruments. In effect, they are paying for the protection against value fluctuation that they believe a particular financial asset provides.

 

Currently, nearly one-third of the global bond market – approximately $16 trillion – has negative interest rates.

 

Negative interest rates stimulate economic activity, but they are risky.
The primary reasons for central banks implementing negative interest rates are to avoid or recover from recessions and to prevent their currencies from overheating. However, central banks must perform a delicate balancing act because negative interest rates can lead to significant debt problems.

 

They reduce interest rates on business loans and mortgages, which stimulates economic activity and aids in the stabilization of a country's economy. In response to the enormous economic damage caused by the pandemic, the United States reduced its rate to 0.25 percent, while the European Union (EU) maintained its own at zero. However, the deposit rate in the EU is negative, at -0.5 percent. While the United States never went into the negative interest-rate territory, it came very close, and if the economy faltered in its recovery, the Federal Reserve would undoubtedly consider it.

The United Kingdom cut its own rate to 0.1 percent to combat the economic impact of the pandemic, but it is actively considering negative interest rates if the economy "crumbles." The pandemic had a greater impact on the UK economy than most, but it is the economic impact of Brexit that may force the country to pursue negative interest rates.

 

If a country's currency is overvalued, negative interest rates, in theory, reduce the investor incentive to buy it. The latter scenario is especially advantageous for exporters, who will suddenly discover that their currency is less expensive for overseas clients to purchase. Of course, the opposite is true for importers, who have less purchasing power in foreign currencies.

 

Negative interest rate countries

There are currently three countries with negative interest rates, in addition to the 19-member eurozone bloc.

Switzerland (-0.75%), Japan (-0.10%), and Denmark are the three countries (-0.60 percent ). As previously stated, the EU deposit rate is 0.5 percent, implying that the 19-member eurozone countries operate with negative interest rates from Germany to Italy, and from Ireland to Spain.

National central banks will have to pay the supranational European Central Bank (ECB) a 0.5 percent interest fee for the privilege of depositing money with the ECB.

 

The Effect of Negative Interest Rates on Foreign Currencies

As negative interest rates become more prevalent, their link to currencies becomes more significant as rates move through the economic cycle.

This scenario benefits countries with higher interest rates because weaker currency valuations support a country's exports, making them more appealing to outside investors. As currencies depreciate in value, the price of imported goods rises, creating a surge in demand for the country's increasingly affordable exports.

 

However, negative interest rates have drawbacks in the country or region that implements them.

 

Demand for that country's currency, for example, may fall in countries with aging populations, such as Japan. Seniors on fixed incomes may spend less as interest rates fall, because they frequently use discretionary income from investment interest to purchase a large-ticket item, such as a refrigerator or a new vehicle. That scenario may be mitigated somewhat because younger consumers may see negative interest rates as a reason to buy that refrigerator or vehicle because they will pay less in interest on the purchase.

That has largely been the case in Denmark, where homebuyers have been rushing to finance new home purchases at negative interest rates since the country implemented them in 2012.

 

We're not going anywhere, and others may join us.

While negative interest rates were initially devised as a short-term economic policy measure to stimulate country economies, the reality is that negative interest rates are now entrenched in countries such as Japan and Denmark. This is a risk that could occur elsewhere.

Negative interest rates, if allowed to persist in the long term, are causing concern in economic circles, where policymakers wonder if disruptive financial markets, declining bank margins, boomeranging currency fluctuations, and weakened worker pensions will also persist. According to Bloomberg, investors believe the current trend of negative interest rates will “end in capitulation” for the world.

That is the risk of opening the door to negative rates, which have broken through and show no signs of abating, and which will almost certainly spawn more negative rate movements in other countries over the next few years.

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