Negative Interest Rates and Their Implications on Capital Markets
The last three years have witnessed worldwide, a significant shift in how central banks manage interest rates. Central Banks are becoming more bold and unpredictable, especially that they are now adopting negative interest rates for many major currencies such as the Yen, the Euro, the Swiss Franc, the Swedish and Danish Krona.
These “unusual” steps taken by the Central Banks, have shed the light on many major issues, including the impact of interest rates on the economic activity, or on the monetary assessment of a specific currency and the urge to always change its rate to protect its strength against the dollar and other international monetary currencies.
There is no doubt at all that these exceptional monetary policies are part of the worldwide financial crisis that allowed for a currency war to take place, yet this war has led eventually to a wave of negative interest rates, the thing we are currently observing and has, until now, not been defined by any certain time limit.
What are then the motives behind this new adoption and what are the most prominent results until now and eventually who is the final beneficiary of all that is happening?
ECB has set the interest rate on the euro on 0% and -0.4% for the banking deposits. BOJ took similar steps, setting a negative interest rate on the Yen that has reached -0.1%. Both banks aim through these steps to reduce the desire of commercial banks in Europe and Japan to create cash deposits with their central banks, but instead, to use their surplus liquidity in the activity of banking, the thing that could stimulate the overall economic cycle, that is now measured by the level of inflation in the country.
In parallel, Swedish, Danish and Swiss Central Banks adopted negative interest rates, to control the strength of these countries’ currencies that are often considered as safe havens, for which demands on them increase for hedging purposes. This thing leads to the increase of their value and consequently, to the loss of their competitiveness in international trades, especially for countries like Switzerland and Sweden, where exports activities are considered as a huge support for the national output.
Whatever were the reasons behind adopting negative interest rates, we can resume its’ more important results by the following:
- Some countries such as Germany and Japan managed to boost their shares of international exports, because of the decline of the euro and yen. This increase in the trade balance have improved the payment balances of both countries, and enabled them to grow their cash reserves. From here, we can understand why these two countries prefer low interest rates for both the Euro and the Yen, against the US Dollar. In other words, the weakness of these currencies may be regulated by monetary authorities in both Europe and Japan
- Despite the slight improvement that occurred on inflation levels of the countries that adopted negative interest rates levels, they are still far from the level that makes an economic boost, and that is usually between 2% and 3%. This means that deflation on prices is still dominating these countries.
- Instead of improving the credit’s activity, banks and financial institutions have invested their liquidity in the stocks and bonds markets, that have hugely increased, thanks to its reversal relation with interest rates levels. Consequently, these institutions have effectively adjusted the target of the negative interest program, as they have hugely invested in the capital market, instead of investing in the real economy, through acquiring individual and institutional loans.
Finally, there is no doubt that capitalists do not actually desire to invest their money in deposits accounts that give negative interest rates. On the other hand, investing in the stock market has become very risky in the recent period, due to the dominant’s trend, that is not correcting at all rising constantly without any interruption, and most of all, because the market price significantly exceeded the book value. From this perspective, Gold remains the haven that could preserve the value of the wealth, that’s why Germany, Switzerland and India for example are returning now to the individual demand for Gold, after an interruption that lasted for 3 years.