We wrote
in one of our daily articles that Sweden
had cut its main interest rate into negative territory (-0.10 percent). That
way the Riksbank followed other European central banks. Currently, except
Sweden, the negative interest rates are set by the Central Bank of Denmark,
the European Central Bank and the Swiss National Bank. What does such a
historically unusual monetary policy mean for the financial markets?
There is no
single general answer, because there is a special story behind each
occurrence of a negative rate. For example, the Danish and Swiss cuts were
related to managing their currencies rather than to stimulate growth or boost
inflation. The Danish kroner is pegged to the euro, so its central bank cuts
its certificates of deposit rate (these certificates are used in the
open-market operations) into negative territory (currently at -0.75) in order
to prevent appreciation of the currency against the weakening euro. A similar
rationale was behind the Swiss National Bank’s move, which cut interest rates
into negative territory (now at -0.75 percent) in order to prevent capital
inflows and neutralize the frank’s appreciation after removing its peg to the
euro. In the case of Sweden, the most popular explanation involves
deflationary concerns; however the Riksbank could also cut its repo rate in
the context of currency wars, because the Swedish kroner has been
appreciating against the euro since the end of 2014.
The story of the
euro is slightly different, because the Eurozone is not a small open economy,
like Switzerland, Denmark or Sweden, which is afraid of capital inflow and
currency appreciation due to problems in the Eurozone. Although we cannot
preclude the ECB desire to weaken the euro against the U.S. dollar (the
decline in interest rates could discourage foreign investors from placing
their liquidity in the Eurozone), it does not seem to be the main reason
because the monetary planners from Frankfurt cut the deposit facility rate,
which is a rate on the excess reserves. The ECB cut this rate for the first
time in June 2014 from 0 to -0.1 percent and cut it again in September 2014
to the current -0.2 percent. That way the ECB wanted to provide further
monetary policy accommodation and induce banks to lend money from excess
reserves into the ‘real’ economy and boost inflation and the economy.
Graph 1: ECB’s
deposit facility rate from 2013 to 2015 (in percent)
What are the
consequences of negative interest rates? It seems that not so big, because
their level is not very low. Moreover, the deposit rate facility is not the
main financial tool used by the commercial banks doing business with the ECB.
And they are not forced to hold their excess reserves in deposit accounts (with
negative interest rates) – they can keep them in their current accounts. The
most important thing is that, contrary to what many analysts believe, the
lowering deposit rate into negative territory does not lead banks to lend
them out to the private sector. This is because banks do not lend reserves to
the nonbank private sector. In other sectors, the banking sector as a whole
cannot reduce its reserves – the reserves that leave one bank’s balance sheet
just pop up on another. This explains why loans to the private sector in the
Eurozone have not increased, but have actually fallen substantially after the
reduction of the ECB deposit rate from 0.25 percent to zero in July 2012. So,
why has the ECB has introduced them?
The hidden
reason may be an attempt to recapitalize southern banks. They do
not possess much in excess reserves, but the northern banks have a lot of
excess reserves. Thus, the negative deposit rate may induce the Northern
banks to lend their excess reserves to Southern banks in order to partially
avoid the negative rate tax. It means that the situation in the peripheral
Eurozone is not as strong as many believe.
Negative deposit
rates also impose some costs on banks, which may lower
their profitability and even aggravate the problem of
sluggish lending. Another important effect is the increase of a
relative attractiveness of investing in alternatives, such as gold or
Treasury bonds.
This is exactly
what we are seeing right now. According to Bloomberg, in
Switzerland, “investors are buying more gold as an alternative to hold Swiss
franc cash deposits”. As we already explained inOctober’s Market Overview, lower interest
rates mean lower opportunity costs of holding non-interest bearing assets,
like precious metals, making them relatively more attractive. If you
can earn, say, 2 percent on the deposit, the investment in gold,
which you have to store and insure, and pay, say, 1 percent, does
not sound very compelling. But when you suddenly have to pay 0.75
percent to hold paper currency, gold looks much better.
This is also why
we are witnessing an increasing demand for some European government debts,
mostly in Denmark, Switzerland and Germany, which is reducing yields even
into negative territory. Yes, it seems strange at a first glance. Why the
hell do investors agree to pay for lending money? However, it becomes fully
understandable when we take into account the current situation in the
Eurozone. In short, investors are eager to pay for holding safe assets,
because they fear the collapse of the euro. You can think about such a deal
as a currency playing or buying an option. Investors pay the premium, but when
the Eurozone breaks up, they would hold gold, Swiss francs or bonds of the
relative rich and stable northern countries like Germany, Denmark or Finland.
In other words,
some investors are quite pessimistic about the overall economic outlook for
the continent and the future of the Eurozone. They are so desperate
in their search for safe havens that they pay for the privilege of lending
money. Similarly, the recent unconventional central banks’ actions
show that they are really desperate. It signals that not
only did all the previous monetary stimuli failed to fuel the economy, but
also that the global slowdown is coming. Look at the producers’
price indices. The central bankers, as insiders, know that deflation in
commodity and industrial prices indicates the crack-up phase of the business
cycle.
To sum up, the
recent events in Europe seem to be bullish for the gold market. The
Eurozone crisis will come sooner or later. Investors predict rather sooner,
at least drawing conclusions on the basis of the level of yields on
Treasuries. The central banks introducing negative interest rates and
implementing quantitative easing (the Riksbank and the ECB), show that a
global slowdown is on the horizon. As we constantly repeat, gold
is historically the best asset class during slowdowns. The safe haven demand
(remember that the Swiss franc, which is traditionally considered as a safe
haven currency, is now relatively less attractive) and very low real interest
rates would also positively contribute to the prices of gold.
Would you like
to understand the negative interest rates, something economists thought was
impossible? We focus on the macroeconomic implications for the gold market in
our monthly Market Overview reports; however we provide also Gold &
Silver Trading Alerts for traders interested more in the short-term prospects.
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