Negative interest rates, a tool over-used

Groundhog day

I keep thinking negative rates are a complex animal no one knows yet the potential consequences on the long run. It was supposed to be a tool of monetary policy and not a gift. Of course, now with the inflation of State indebtedness it is a good thing (especially when government bond issues are not floored at zero). However, in the long run, it may have heavy impacts on the whole economy and financial system. The solution to recover can come partly from low interest rates but also form a more aggressive fiscal policy. They are an indicator of deep economy troubles and bring, as I already several times underlined, harmful side effects on pension funds and other investors, banks and insurance companies. We can easily understand that cutting rates below zero should remain exceptional and an in-extremis solution part of Central Banks toolkits. We should not cheer negative rates. Investors are betting these days on potential negative rates coming in the US and UK. We will see but European and Japanese are not yet really convinced this policy works… so far. The still positive rates countries have the privilege to see ho the experiment has played out elsewhere. After a 6-year experience in EUR zone, we can suggest that negative rates have been a wrong policy or at least that it didn’t deliver what was expected. There is a level below which lower rates stop stimulating the economy and start acting as a drag. Why having negative rates when they are floored in credit facilities? These negative rates can cause long term problems we should not occult. People in Germany have bought safes and keep cash at home or in banks’ individual safes. Was it the objective? I don’t think so. We are all looking how to remove cash and fiat money, as in Sweden or in Israel, while some countries push people to accumulate fiat money. It is contradictory. Negative rates come with all the downsides of loose monetary policies generally, such as boosting wealth inequality and encouraging businesses and households to take on debt. But in some countries the lower the rate the more people save money to compensate losses in return. It is a paradox, although a fact we have noticed. Low yields can prompt excessive risk-taking approaches. In Europe, if politicians have been able to launch coordinated fiscal stimulus, they could have avoided the ECB negative rates strategy. We missed the train. It explains why Swedish have tried another route and are back to positive territories.

Monetary or fiscal policy?

I believe it will be hard for European States to escape from fiscal gifts when unemployment remains high and will keep increasing over next months. Many companies are over-indebted and will remain at risk. The fragility of such a debt-burdened economy will prevent central banks and ECB to raise interest rates, unless inflation is back (we can be suspicious even if some economists announced it). ECB will be reluctant to move rates up to combat expected inflation for fear of killing completely recovery. Lagarde doesn’t want to cause further problems but to sort them out or to help and serve the recovery, while not jeopardizing her independence. We all would prefer inflation, sign of a recovering and booming economy. Unfortunately, we are still in the mist and it is too early to predict anything on size and timing for recovery.

Long winter with sub-zero rates…

Negative interest rates are one of the biggest problems European banks have as it affects their business. It happens when nothing else works. In the US I guess they want to avoid such a situation. Negative rates mean lower returns for banks and other financial institutions or funds. Unfortunately, with the current health crisis and its consequences that can last for a while, I do not see the end of these below-zero rates before months and years. We are sort of prisoners of our policy, which only benefits to the governments facing increasing debts.

Fran?ois Masquelier,   SimplyTREASURY