Getting paid to take a loan or a mortgage, sounds nice doesn’t it? In Japan and across Europe, negative interest rates are becoming a reality and are starting to have real consequences in day to day life. The effects of negative interest rates are complex and they impact a wide range of areas beyond just borrowers. Savers, banks, companies and governments are also affected by the repercussions.
We explained what happens when interest rates are negative and what it means for your money!
What are negative interest rates?
Everything has a price, including money!
For a given country, the price of money is set by the Central Bank through interest rate. It is the interest rate that a commercial bank gets when it stores excess reserves with the Central Bank. Even banks need a bank!
Through this interest rate, the Central Bank is nudging the direction of the rates to which commercial banks should be lending money to individuals and businesses.
When interest rates are negative, it means that a commercial bank should pay to store its money with the Central Bank. It is a strong incentive for the banks to lend the money rather than keeping it.
A Negative Interest Rate Policy (NIRP) from a Central Bank is an extreme measure. It can mean that there is a very high risk of Deflation (price falling) in the economy. The Central Bank is trying to stimulate the economy by injecting more liquidity in the system through lending.
If, as a consumer, you think that the price falling is a good thing, think again. Deflation could be a vicious circle because consumers keep postponing consumption, expecting prices to fall even further. If deals will be better tomorrow you keep waiting for the next deal.
Prices start to fall because we have overcapacity in the economy compared to economic demands. This could lead to unemployment or salaries decreasing, further depressing economic growth!
In theory, negative interest rates are potentially a good tool to fight Deflation by stimulating lending. This has been a reality for several years across the world.
Which countries have negative interest rates?
Japan and Europe are facing similar demographic challenges with their population getting older and slow economic growth. Central Banks in these regions have been implementing negative interest rates to sustain the economic recovery following the crisis in 2008.
Japan has been struggling with deflation since the 1990s. According to ING economists Carsten Brzeski and Inga Fechner, the Japanese economy has been in deflation for almost half of the time since 1994! The Bank of Japan (BOJ) adopted negative rates in 2016. The rates are still partially negative since then.
In Europe, we have an explosion of negative interest rate policies being implemented to put pressure on commercial banks. Sweden pioneered this trend in July 2009 just after the economic crisis. After adjusting its rate to 0%, the Riksbank, the central bank of Sweden, returned to negative rate between 2015 and December 2019. Denmark National Bank (DNB) did the same in 2012. European Central Bank (ECB) deposit rates have been negative for the Euro zone since June 2014. The Swiss National Bank was the last to introduce such policy in 2015.
How do negative interest rates affect mortgages?
For many years the impact of negative rates on the commercial banks were not visible, but this is starting to change.
In August 2019, the Danish bank Jyske Bank became the first to pay borrowers to get a mortgage! It introduced a 10-year fixed-rate mortgage at negative -0.5%. In practice, you still have monthly repayments but you have to pay less than you borrowed in total.
Getting a mortgage in Denmark is extremely cheap. Nordea Bank offers a 20-year fixed-rate mortgage at 0% and a 30-year fixed mortgages at 0.5% interest rate!
With such low rates, banks may try to make money by charging a fee or selling additional services like mortgage insurances for example.
Getting paid to take a mortgage is nice but you may need to borrow much more because everyone is accessing cheap mortgages and houses prices are rocketing up. In 2019, Danish house prices reached a new all-time high in nominal value.
In Sweden you have the same trend. With cheap mortgages house prices are expensive and household debt exploded to its highest level ever; representing 90% of the Swedish GDP.
How do negative interest rates affect savings accounts?
In the same way that negative rates may encourage you to borrow and spend money, they are also a strong incentive not to save money.
In countries with negative interest rates, we start to see a trend of banks passing these negative rates to savers!
The trend started to impact wealthy clients first. In Switzerland, the banking group UBS has been charging a deposit fee of -0.75% to rich customers with at least 2 million Swiss francs on their savings account (= at least CHF15,000 yearly fee to pay). Being rich is expensive. Another bank, Credit Suisse, is charging a fee of -0.85% if you hold more than 10 million swiss francs on your savings accounts. And Postfinance, the equivalent of the Post Office in the United Kingdom, is also charging a deposit fee under certain conditions.
As we saw above, in Denmark you can get a negative mortgage with Jyske Bank. But the same bank will charge you a negative interest rate of -0.6% if you have more than 7.5 million danish krones (around £854,000) on your bank account.
And the pressure is mounting even on small savers. In Germany, a Bavarian co-operative bank, Volksbank Fürstenfeldbruck, is charging a negative interest rate of -0.5% on instant access savings accounts even if you only have a deposit of €1! It was the first time that a Bank passed the cost of negative interest rates to customers with a small deposit.
In European countries where savers need to pay banks to keep their cash on savings accounts it is too early to see the impact on consumption. The danger is that instead of spending, savers could start to take more risks. Either by physically keeping more cash at home or investing into financial products which are riskier to avoid the effects of negative interest rates.
How negative interest rates affect your debt?
On a positive note, negative interest rates are an excellent opportunity to refinance and to consolidate your debt at a cheaper rate.
The challenge is that a negative interest rate can cut the ability from banks to make a profit. And it could make them extremely selective. You have a risk that only excellent creditworthy borrowers could access the money at very low or negative rate while excluding borrowers with a bad credit score.
This trend would be accentuated by the fact that if savers are stopping to place their money on savings accounts the banks may have less money to lend.
How negative interest rates impact government bonds?
In 2019, the total value of bonds with a negative yield topped $17 trillion globally (from nothing in 2012). Government bonds from Japan, France, Germany, Spain or Italy are generating negative yields.
It can happen for bonds offering a very low interest rate which won’t compensate the premium that investors may pay if the bond price is higher than its face value.
Negative yield means that the return is negative due to the bond price but it doesn't mean that you have negative interest rates bonds. Governments still need to repay the full amount of the debt borrowed.
So far we have never had a case of negative interest rates government bonds. In August 2019, Germany sold 30 year bonds with a zero coupon. It means that you would lend money in 2019 and get the same amount back in 2050. The German government would not pay you interest in exchange for your money despite you taking the risk of not getting repaid and the cost of inflation.
Even for Germany, 0% interest rate was a hard sell and only 40% of the bonds were bought. But this situation could become more and more common as interest rates keep falling across the world despite countries borrowing more.
Can negative interest rates happen in the UK?
Negative interest rate may happen in the United Kingdom if prices fall into deflation or economic growth is depressed after a crisis. It would be an extreme measure to stimulate the economy.
But as we saw, overall, you probably don’t want negative interest rates to happen in the UK. Apart from people with a good credit score it is possible that a large number could not get access to cheap money and get frustrated if house prices keep increasing for example. Savers would also face the situation of having to pay to put money into a savings account.
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