Negative interest rates... the dangerous new craze?

Central Banks have a growing love of negative interest rates. It is quickly becoming the new QE, with Japan and Switzerland being the largest adopters. The basic idea of negative interest rates is to incentivise banks to lend more money or invest with longer time horizons. Central Banks achieve this by charging banks to use their overnight facilities,discouraging banks from holding cash. This is a very new tool in the central bank toolkit however the full implications are yet to be seen.

The horizontal axis on the graph below shows government bond maturities. The red blocks depict government bonds with negative interest rates and their given maturity. What does this tell us about these countries? First off, almost half of government bonds with a ten year or shorter maturity have a negative rate. This could mean two things. One, investors are concerned about the riskiness of other investment classes and would rather park their money where they will receive a small loss as compared with a potentially larger loss elsewhere. Secondly, global inflation is well below central bank targets – the graph suggests inflation could fall even further. If this view becomes entrenched, parts of the developed world may see a damaging deflationary spiral.  

We believe this new tool could lead to a range of unexpected (and unwanted) consequences. The year ahead will be an interesting one…

post by Karl Geal-Otter

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