How low can interest-rates go?

The subject of negative interest-rates has been a theme of this website since back in 2010. It is also pleasing that the two main candidates from back then ( Bank of Japan and the European Central Bank ) have indeed plunged into the icy depths having official interest-rates of -0.3% and -0.1% respectively. Added to these we have seen nations on the periphery of the Euro area forced to join the club such as Sweden,Denmark and Switzerland. You can debate which has the lowest interest-rate as whilst the headline in Switzerland is -0.75% compared to Sweden’s -0.35% the Riksbank has set a deposit rate of -1.1%.

A Problem

In essence it is not working. The issue is complex as the central banks involved are invariably using other methods too such as QE (Quantitative Easing) or currency intervention. However if we look at Japan then Governor Kuroda would have expected a higher level for the equity market and a lower level for the exchange-rate of the Yen. What he has got is a Nikkei 225 falling this morning to 15,713 and a Yen which has strengthened through 115 versus the US Dollar. If we look at it versus the UK Pound £ then the initial effect was to weaken the Yen as it moved from 170 being required to buy a Pound £ to 173. But that reversed and it is now 116.4

The situation in the Euro area is that there has been an improvement in terms of economic growth but a relatively weak one when you consider that it has thrown the monetary equivalent of the kitchen sink at it! Or as we shall see in a bit what we thought was the kitchen sink. Also it finds itself mulling a measure of inflationary expectations that yesterday was worse than when it began its 60 billion Euros of QE a month in January 2015. Not much bang for your buck there.

Lower interest-rates are supposed to stimulate an economy however I have regularly argued on here that around the 1.5% area the effect fades and may well head the other way. So we have the risk that what is badged as a stimulus is in fact deflationary. Putting it another way consumers and workers decide to sing along with the Who.

Then I’ll get on my knees and pray
We don’t get fooled again
No, no!

What is next?

Those who feared a race to the bottom on interest-rates have received quite a bit of grist to their mill over the past couple of days. The Jefferies strategist David Zervos opened the bidding on Monday on Bloomberg.

Looking ahead, I am not sure how quickly Mario [Draghi] and Haruhiko [Kuroda] will come to the conclusion that purchases need to be in the multiple hundreds of billions per month, and nominal short rates need to be LESS than MINUS 1 percent.”

I suggest when reading such thoughts you put this song by Andrea True Connection on.

More, more, more
How do you like it, how do you like it
More, more, more
How do you like it, how do you like it

Of course the ECB had already hinted promised and teased about an interest-rate cut in March. May I just point out the insanity of a 0.1% cut when 5% lower has not worked ( as otherwise why is more needed?). Anyway JP Morgan have leapt into the breach and suggested not only a cut to -0.5% in March but a further one to -0.7% in June. If you think about it then why not cut straight to -0.7%? Apparently highly paid strategists are not as talented as we are often told. Or they are admitting that this is in effect a Public Relations exercise.

At what level do we see real change?

It was thought in the past that even dipping a toe into the world of negative interest-rates would lead to a switch back towards cash. So far even as low as -0.75% this has not happened according to Denmark’s Nationalbanken.

Currently, there are no indications that negative interest rates have led to abnormal demand for cash. This indicates that the lower bound on monetary policy rates in Denmark is below the current level of the rate of interest on certificates of deposit of -0.75 per cent.

Yes that is the same lower bound that Bank of England Governor Mark Carney told us was at 0.5% before yet another u-turn. However there is a significant addition to this.

In this context, it is important that household deposits have not moved into negative territory.

So the move is going to work by not affecting most people? My argument gets reinforcement as does the idea of there being a type of what was called a liquidity trap being in play. Please note this as you will see in a minute that the proposed solution is that even fewer economic agents are affected.

The lower bound gets lower

JP Morgan have via Bloomberg suggested that official interest-rates could go much lower.

On that basis, they estimate if the ECB just focused on reserves equivalent to 2 percent of gross domestic product it could slice the rate it charges on bank deposits to minus 4.5 percent.

Okay and could everyone do that? Apparently not.

The Bank of Japan’s lower bound on a similar basis may be minus 3.45 percent, while Sweden’s is likely minus 3.27 percent, the economists said. Should they also go negative, the Fed could cut to minus 1.3 percent and the Bank of England to minus 2.69 percent in JPMorgan’s view, reflecting how the ratio of reserves to assets is higher in their economies than elsewhere.

There are two obvious flaws in what looks like the sort of cunning plan that may have been constructed by Baldrick from the television series Blackadder. Firstly narrowing the scope of the negative interest-rate regime means that it is even less likely to work. Secondly what if the amount of reserves changes in response to the new interest-rate? Central bankers could end up like a dog chasing its tail with the difference that dogs have the sense to stop this game after a while, whereas I am not so confident about central bankers.

Also central bankers place a lot of emphasis on Open Mouth Operations and confidence as expressed in Forward Guidance well how will this work for Mario Draghi if he cuts to -4.5%?

And now we are at the lower bound, where technical adjustments are not going to be possible any longer.

That lower bound was at -0.2% which of course has already been breached.

The United States

There are calls for negative interest-rates there too. But there may well be a problem according to Bloomberg.

Most notably, it is not at all clear that the Federal Reserve Act permits negative IOER rates, and more staff analysis would be needed to establish the Federal Reserve’s authority in this area.

Oh well I guess we might find a new act on its way….

Comment

There is much to consider and let me remind readers that it is my opinion that we will see the sort of response to negative interest-rates that everyone is afraid of – a dash to cash – at around 2%. This estimate is based on the costs of this and human psychology and inertia. However that assumes that there is cash to dash to and as I pointed out a week ago the establishment is on the case. From Harvard University.

Our proposal is to eliminate high denomination, high value currency notes, such as the €500 note, the $100 bill, the CHF1,000 note and the £50 note.

The justification is familiar.

Global financial crime flows are estimated to amount to over US$2tr per year. Corruption amounts to another US$1tr.

What they fail to address is the fact that most of the corruption and financial crime starts at the top these days! So their arrow will miss the target but not us.

Meanwhile the plan is to cut interest-rates ever lower and to make sure that the banks are not too badly affected by it . Yes it is always the banks. Meanwhile it troubles nobody seemingly apart from me that you only have higher doses of medicines which work not ones which fail. Anyway here is a song from The Cranberries for the latest proposals.

In your head, in your head
Zombie, zombie, zombie
Hey, hey
What’s in your head, in your head?
Zombie, zombie, zombie

In response to a request in the comments I have been looking at forums, does anyone have any thoughts on Simple Press?