April 2016 negative interest rates and impact on the overall economy

If countries have already introduced negative interest rates, these seem to provide only limited stimulus to the domestic economy. We therefore see major challenges for the respective economies.

If countries have already introduced negative interest rates, these seem to provide only limited stimulus to the domestic economy. We therefore see major challenges for the respective economies.

In January, the Bank of Japan became the fifth major central bank to introduce negative interest rates to encourage bank lending and consumer spending and, as a result, growth and inflation. We acknowledge that negative interest rates may significantly increase lending in the short term. However, our analysis also points to a number of unintended consequences that may weigh on the economy in the long run. In this issue, we explain some of our concerns about negative interest.

Redistribution of resources

While interest rates have fallen in all developed countries since the onset of the global financial crisis, banks have largely succeeded in reducing the pressure on their interest rate profit margins: By keeping the difference between the average cost of borrowing and the average price of lending relatively constant. But interest rates increasingly slipped into negative territory. To avoid the likely withdrawal of funds by their retail customers, banks have been able to pass on negative rates only to their commercial customers. So, in addition to the unfavorable regulatory environment and lower profitability due to flatter yield curves, negative interest rates are now raising additional concerns about the future of banks' business models.

To alleviate some of the pressure, banks in some countries have increased (i.e., not reduced, as lower interest rates actually suggest) the cost of financing for households. In Switzerland, for example, risk premiums on mortgages widened after the introduction of negative interest rates (see Figure 1), which may have contributed to the slower growth in residential real estate prices (see Figure 2). Other countries that introduced negative interest rates, such as Sweden, have not yet experienced this phenomenon. In our opinion, higher borrowing costs despite lower capital costs are a clear sign that a negative interest rate environment has unintended consequences.

Figure 1: Swiss interest rates

Figure 2: Residential real estate prices& Figure 3: Household debt as a percentage of gross domestic product

According to the intentions of the central banks, in some countries with negative interest rates more credits were created (see figure 4). However, the situation is somewhat more complex and must be seen in the context of the economic recovery of these countries. They also took other measures, such as quantitative easing, to expand lending volumes. In the euro area, lending to nonfinancial corporations has been rising slowly since the onset of the financial crisis. But tighter regulation (most notably, with asset quality reviews, the "stress tests" and higher Tier 1 capital requirements) led some analysts to believe that financial institutions will become less committed to credit creation. While there is much to be said for this argument, we tend to see valuable stimulus for traditional banks in some of the ECB's actions (particularly the targeted longer-term refinancing operations, GLRGs/TLTROs). We trust that the large cash buffers on corporate balance sheets will successfully offset some of the medium-term threats to credit creation in the region.

Figure 4: Bank lending to non-financial corporations (dashed lines represent negative interest rates)

Currency devaluation for more competitive advantage

Evidence to date suggests that negative interest rates did not significantly help countries devalue their currencies. Exchange rates express the balance between the trade balances of economies and depend on complex interactions of several economic variables (one of which is the interest rate differential between two nations). While the currency depreciated in a very short period of time in some of the countries that were the first to introduce negative interest rates (z. B. Sweden), exactly the opposite occurred in most of the countries. Very pertinent is the example of Japan, where the yen appreciated against the U.S. dollar after the introduction of negative interest rates (Figure 5). This indicates that other fundamental factors (mainly a strong current account and weaker growth in the Japanese economy) are playing a more important role than the widening of the interest rate differential.

Figure 5: Euro (right scale) and yen (left scale) versus U.S. dollar (dashed lines represent the introduction of negative interest rates)


Data from countries that have already implemented negative interest rates suggest they are providing limited stimulus to the domestic economy. Our analysis has shown that better credit conditions or devaluation of their own currency cannot be attributed to negative interest rates so far – at least not as long as banks are stretching their business models significantly. We therefore believe that introducing negative interest rates, or even lowering them further into negative territory, will create major challenges in the long run.

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