Negative interest rates could be coming. What would this mean for borrowers and savers?

There’s a row brewing in the corridors of financial power

The Reserve Bank of New Zealand (RBNZ) recently advised the trading banks that the official cash rate might move from the barely positive into the negative.

Right now the RBNZ is holding off such a move in favour of other monetary stimulus measures.

But the big banks strongly oppose negative rates, arguing they’ve had limited success overseas and that the country’s banking technology isn’t up to it.

For the central bank, however, it remains an option to stimulate spending, investment and employment as part of the COVID-19 recovery. By reducing the cost of borrowing, economic activity picks up — or so the theory goes.

Those turning to unconventional monetary policy include Japan, Switzerland and the European Union.

Negative rates range from –0.1% to –0.8% for selected tiers of central bank deposits.

In the past, cash rate changes have fed through to changes in loan and deposit rates.

For example, a 25-basis-point drop in the cash rate may result in an annual interest saving of $2,500 on a NZ$1 million loan.

At the current low interest rates, however, these changes are no longer passed on — significantly limiting the powers of the RBNZ.

Yes, the bank pays you to borrow

It might sound crazy, but if the lending rate is negative and you borrow an amount on interest-only terms, the bank actually pays you interest every period.

For example, Jyske Bank in Denmark is offering negative interest payments by effectively reducing the repayment period.

Banks should be comfortable offering negative rates to borrowers if, in turn, the banks themselves have savings and other funding at even lower rates.

But this is the issue: why would savers pay banks to accept deposits?

First, they can hold their investments in cash at a zero-interest rate rather than pay a bank.

Second, they can choose to invest in riskier assets with positive interest rates.

Because of this, only very large depositors (with limited ability to store cash) tend to leave their money in banks offering negative rates, while ordinary depositors receive a rate of zero or more.

But do negative rates work?

Arguably, the era of monetary policy as a tool for stimulating economic investment and activity has come to an end.

Negative rates don’t necessarily translate into productive investment and growth.

Countries that have gone negative have not delivered the expected increases in spending and investment.

Furthermore, the difficulty of passing negative rates on to depositors means lending and deposit rates no longer follow the cash rate.

This is also evident in Australia, where a cash rate drop from 0.25% to 0.1% has not been passed on to mortgage borrowers, except in isolated areas such as fixed-rate loans.

The chart below compares the average variable rate on mortgages with the New Zealand cash rate, with the gap growing over time.

Source: https://propertyupdate.com.au/negative-interest-rates-could-be-coming-what-would-this-mean-for-borrowers-and-savers/?mailchimp=true