Whilst so much of the media and indeed the world were focusing on the travails of my old employer Deutsche Bank yesterday something else significant sneaked under many radars. This was the International Monetary Fund lecturing Switzerland on the subject of negative interest-rates as you can see below.
Calibrating the negative interest rate differential so as to discourage persistent inflows that can cause prolonged deflation and weaken activity is appropriate.
A rather flowery way of suggesting an interest-rate cut from the present -0.75% which is reinforced here.
Some widening of the current effective interest rate differential—either by lowering the exemption threshold or the marginal policy rate—could therefore be considered to reduce the frequency of small-scale interventions.
So the IMF would prefer that Switzerland cut its interest-rates again further into negative territory rather than intervene in foreign exchange markets. That is intriguing on two fronts and the first is the fact that it is tempting it to test where the lower bound is which I shall define as the point at which bank depositors switch to cash. The second is that it is setting interest-rate for foreigners and foreign investors rather than the domestic economy. Indeed for the domestic economy there is potentially trouble ahead according to the IMF.
Sustained low interest-rates could raise financial stability risks……..Elevated household debt and banks’ concentrated exposure to mortgages could be key amplifiers in the event of macroeconomic shocks .
Reality for Denmark
This made me think of the country which has had negative interest-rates for the longest as Denmark plunged into that icy cold world in early July 2012 when it cut to -0.2%. They have been there since apart from a brief foray to the not so giddy heights of 0.05% in late spring and summer 2014. Also if the IMF view extends to other countries which set their interest-rate more for the foreign exchanges than domestic demand there might be another reverse ferret on its way.
Effective from 8 January 2016, Danmarks Nationalbank’s interest rate on certificates of deposit is increased by 0.10 percentage point to -0.65 per cent.
As it was nobody was expecting an end to negative interest-rates anytime soon according to the Nationalbanken or DNB.
The implied overnight interest rate does not reach 0 per cent until in four years
The ordinary experience
This is for borrowers as follows according to the DNB.
Viewed over a longer period, there has generally been close to full pass-through from the rate of interest on certificates of deposit to the banks’ lending rates.
We note they took their time and wonder about how we define close but okay. However the experience for the ordinary depositor remains different.
The banks have been hesitant to pass on the negative rate of interest at Danmarks Nationalbank to small enterprises and especially to households. The latter have been completely exempt from negative deposit rates.
I have wondered along the line of the lyrics below about this.
How long has this been going on?
How long has this been going on?
As far as we can tell banks will continue to resist passing on negative deposit rates to the ordinary investor. However businesses are not exempt as some 30% of deposits are and I have pointed out the dangers to long-term business models from them.
Negative deposit rates are in widespread use for insurance and pension companies, for which the alternatives to bank deposits are placement on money market-like terms, e.g. in short-term securities, likewise at negative rates of interest.
Actually it would now appear that the pension industry likes very few potential futures.
Some pension companies have reported to the Danish Financial Supervisory Authority that substantial interest rate hikes would be the worst scenario imaginable for them.
The Danish Mortgage Bank data is delayed but in week 22 of 2016 then the average short-term rate was -0.23% in Danish Kroner and -0.13% in Euros. The long-term rate was 2.65%.
Any signs of trouble?
If we were to find any they would be found in asset markets of which the likeliest is house prices. On that I noticed this in the DNB Monetary Review.
Since March, the yield on mortgage bonds has fallen more sharply than the yield on government bonds,
Rather awkwardly the rally was driven by foreign investors noting that the ECB (European Central Bank ) is buying such bonds ( covered bonds) in the Euro area making the Danish variety look more attractive. So what about the housing market.
Let me hand you over to a report earlier this month from the DNB which opens with an official denial of what Taylor Swift would define as “Trouble,Trouble,Trouble”.
Although house prices have risen considerably over the last 3-4 years, there are no indications that the Danish market overall is experiencing a speculative house price bubble.
Ah so over the period of negative interest-rates! In case you are wondering about the overall state of play here it is.
But today’s annual increases of 4-5 per cent do not indicate a bubble.
However it has been ” Wonderful! Wonderful! Copenhagen” for those who have invested in property there.
However, price increases in Copenhagen have been so persistent and strong that the development could be consistent with a bubble according to the test, just as in the mid-2000s……. So Danmarks Nationalbank finds that there is reason to monitor developments in Copenhagen closely.
So we learn that monitoring closely is one step up from being “vigilant” in central banker speak. Also those who want to buy in Copenhagen must feel excluded in many cases.
The Real Economy
This has been troubled during this period but has so far in 2016 seen a better phase recording quarterly GDP growth of 0.7% and then 0.5%. But considering the monetary stimulus the forecasts are hardly stellar.
Danmarks Nationalbank expects the gross domestic product (GDP) to grow by 0.9 per cent this year, rising to 1.5 and 1.8 per cent, respectively, in the next two years.
However according to the Governor there may well be trouble ahead.
“We expect the economy to reach its normal capacity level as early as 2018. Conducting expansionary fiscal policy well beyond that point is risky, especially if interest rates continue to be very low. There is a risk of overheating and economic imbalances, which it may be necessary to take measures to prevent,” says Lars Rohde.
He also thinks that fiscal policy needs tightening which means that the current establishment memo seems to have forgotten to be sent to Denmark.
There is much to consider here. Firstly I think that advocates of monetary stimulus have to conclude that the effect on economic growth has disappointed. Denmark has simply not had much and if you factor in the lower oil price it has not done well at all. As to specific news we have reports in the Copenhagen Post of businesses bring production home but also the problems of world shipping are affecting Maersk on the other side of the coin.
Meanwhile we are seeing another move higher in house prices which has even the central bank getting out its slide rule for bubbles! I also note it seems to be hinting/asking for higher taxes on property. On that front well as we see yet another record low for the 2 year bond yield of Germany as it get safe haven flows because of the problems of Deutsche Bank we may yet see more downwards pressure on interest-rates and yields. Oh and as Elton John put it “Please don’t shoot the piano player” about the last sentence.
Something rather familiar to UK and US readers is found in Denmark which is that employment has done better than GDP growth which raises a familiar concern and theme.
Productivity growth in the Danish economy has been weak in the wake of the financial crisis. This is especially the case from the 2nd half of 2015 and onwards when the decoupling of output and the labour market situation calls into question future productivity growth and the actual sustainability of the growth in employment seen during the last year or so.
I was interviewed on the evening show by Simon Rose yesterday.