How does negative rate policy work?
TOKYO, Aug 14 (Reuters) - Negative rate policy - once
considered only for economies with chronically low inflation
such as Europe and Japan - is becoming a more attractive option
for some other central banks to counter unwelcome rises in their
This is how a negative rate policy works and its potential
WHY HAVE SOME CENTRAL BANKS ADOPTED NEGATIVE RATES?
To battle the global financial crisis triggered by the
collapse of Lehman Brothers in 2008, many central banks cut
interest rates near zero. A decade later, interest rates remain
low in most countries due to subdued economic growth.
With little room to cut rates further, some major central
banks have resorted to unconventional policy measures, including
a negative rate policy. The euro area, Switzerland, Denmark,
Sweden and Japan have allowed rates to fall slightly below zero.
HOW DOES IT WORK?
Under a negative rate policy, financial institutions are
required to pay interest for parking excess reserves with the
central bank. That way, central banks penalise financial
institutions for holding on to cash in hope of prompting them to
The European Central Bank (ECB) introduced negative rates in
June 2014, lowering its deposit rate to -0.1% to stimulate the
economy. Given rising economic risks, markets expect the ECB to
cut the deposit rate, now at -0.4%, in September.
The Bank of Japan (BOJ) adopted negative rates in January
2016, mostly to fend off an unwelcome yen spike from hurting an
export-reliant economy. It charges 0.1% interest on a portion of
excess reserves financial institutions park with the BOJ.
WHAT ARE THE PROS, CONS?
Aside from lowering borrowing costs, advocates of negative
rates say they help weaken a country's currency rate by making
it a less attractive investment than that of other currencies. A
weaker currency gives a country's export a competitive advantage
and boosts inflation by pushing up import costs.
But negative rates put downward pressure on the entire yield
curve and narrow the margin financial institutions earn from
lending. If prolonged ultra-low rates hurt the health of
financial institutions too much, they could hold off on lending
and damage the economy.
There are also limits to how deep central banks can push
rates into negative territory - depositors can avoid being
charged negative rates on their bank deposits by choosing to
hold physical cash instead.
WHAT ARE CENTRAL BANKS DOING TO MITIGATE THE SIDE-EFFECTS?
The BOJ adopts a tiered system under which it charges 0.1%
interest only to a small portion of excess reserves financial
institutions deposit with the central bank. It applies a zero or
+0.1% interest rate to the rest of the reserves.
The ECB is also expected to take "mitigating measures", such
as a partial exemption from the charge in the form of tiered
deposits rates, if it were to deepen negative rates from the
current -0.4%, analysts say.
But designing such a scheme won't be easy in a bloc where
cash is distributed unevenly among countries. It could even
backfire by pushing rates up in certain countries, rather than
(Reporting by Leika Kihara in Tokyo and Balazs Koranyi in
Frankfurt; Editing by Alex Richardson)
First Published: 2019-08-14 01:00:32
Updated 2019-08-14 01:00:48
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