Jamie Jemmeson ACSI
May 22, 2021

What are the Pros and Cons of Negative Interest Rates?

At the start of the year many thought that negative oil prices could never materialise; in April, the world saw this come to reality with below $0 oil prices for the first time in history. Now the focus is on whether interest rates could turn negative in the UK and US. Recently, Bank of England Deputy Governor Broadbent stated that the central bank would have to consider the pros and cons of negative interest rates. During a recent webinar, BoE Governor Bailey stated that negative interest rates are not on the table now, although he also commented that it was wise not to rule anything out forever. President Trump is never shy of stating his mind, he is piling the pressure on FOMC Chair Jerome Powell. Taking to Twitter, he stated that the US should accept the “gift” of negative interest rates. With the subject matter picking up momentum it is worth reviewing the potential economic benefits and considerations surrounding negative interest rates.

Theoretical benefits

  • By charging lending banks to store their reserves at the central bank, it is hoped that lenders will be coerced into lending more of these funds. By lending money to borrowers, they will earn interest as opposed to being charged to hold their money.
  • To encourage spending by deposit holders. During downturns, both consumers and businesses tend to hold on to their cash whilst they wait for the economy to improve. Rather than paying to hold a deposit at the bank, spending would increase, helping the economy to grow and hopefully avoiding deflationary conditions.

Considerations

  • Banks and lenders have several assets that are tied to interest rates such as mortgages. Negative interest rates could squeeze profit margins to a level where risk/reward no longer make sense, resulting in reduced lending.
  • If consumers start being charged interest to hold money in their bank account, there is nothing to stop them withdrawing all their cash and storing in their cupboard under the stairs. A run on a banks would then become a concern, reducing capital adequacy. We saw this with Northern Rock in 2008, panicked individual depositors withdrew funds as fears grew that their savings might not be available if receivership emerged.

In short

Negative interest rates are deployed to combat deflation by encouraging people and businesses to borrow and spend money. However, this is unconventional policy that has been implemented only a few times in the past.

History has shown how “in theory” does not always turn out to be “reality”. Circumstance and opinion are always changing, what is right in one period might be wrong in a different age.  Given the current conditions it is difficult to fully quantify the effects.

What would be the effects on currency?   

This may come down to how many adopt this unconventional method of monetary policy in these unpredictable times. In theory, if negative interest rates are adopted, the currency of that nation may initially weaken as inward investment drops and overseas deposits decline. However, this crisis is being driven by science and theoretical models so it is hard to say with any certainty what the resulting effects would be.

Hedging tools for business

If your business has currency exposure now or in the future, you may or may not have a strategy and range of tools you utilise to manage this.  We understand that the world has become a little more uncertain and as we adapt, it will be necessary to review all areas of our businesses for efficiencies in cost and strategy.

Infinity International would be happy to offer a complimentary FX review of your current process to offer a fresh perspective and to highlight any opportunities for increased efficiencies.  If you would like to organise a time for an exploratory conversation, please leave your details below.

The review would encapsulate:

  • FX pricing to determine your current cost of your current provider vs Infinity International rate
  • Credit terms to ensure efficiency for cashflow when hedging currency (subject to approval)
  • FX volatility assessment to understand the impact of a significant FX rate change
  • Strategy ideation to align FX risk management with your business objectives