Here's how low interest rates all over the world can go

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When Denmark introduced negative interest rates in 2012, it was a pioneer. But the policy has become such an accepted part of central banks’ toolbox in the years since that financial pundits hardly batted an eyelash when Hungary became the world’s sixth central bank to introduce negative rates in March 2016. As the practice becomes more widespread, the question of how low interest rates can go has become increasingly relevant for investors.  

While every country (or region, in the case of the Eurozone) has implemented negative rates slightly differently to fit their individual needs, the fundamental mechanism is largely the same: In one way or another, commercial banks are charged interest (rather than paid interest) for keeping money on deposit with the central bank. In Europe and Japan, the largest economies to introduce negative rates, those charges are applied only to excess reserves. (Most banks are required to keep a minimum amount of reserves on hand at the central bank, and any additional cash beyond that is called excess reserves.)

Negative rates have raised concerns about bank profitability in several economies where they have been introduced. One reason is that most commercial banks have been reluctant to pass the cost of negative rates onto consumers by charging retail customers interest on their deposits. Another reason is that since negative policy interest rates tend to push market interest rates lower, they can also reduce banks’ income from new or floating-rate loans and bond investments.  

Below, we review Credit Suisse’s take on how likely it is that central bankers in economies that have introduced negative rates will take rates even further below zero, as well as the potential for one important country that hasn’t implemented negative rates to do so.  

Europe  

Credit Suisse does not anticipate that the European Central Bank, which introduced negative rates in 2014, will dip much further into negative territory. At its March 2016 meeting, the ECB reduced its policy rate by -0.1 percent to -0.4 percent, but placed a much heavier emphasis on more direct methods of easing domestic credit conditions. The central bank introduced an investment-grade corporate bond-buying program and a targeted long-term refinancing operation (TLTRO) that essentially flips negative rates on their head, allowing European commercial banks to borrow at negative rates – they get paid to borrow – if they exceed certain lending targets.  

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ECB President Mario Draghi explicitly stated that in the future the bank would prefer to use methods other than rate cuts to stimulate the economy and boost inflation, and that he doesn’t “anticipate that it will be necessary to reduce rates further.”  

Sweden and Switzerland  

If the ECB maintains the current status quo, the Riksbank of Sweden and the Swiss National Bank should feel less pressure to further reduce their own already significantly negative rates. (The Swedish deposit rate is now -1.25 percent, and the Swiss rate is -0.75 percent.) Why is that? The central banks introduced negative rates largely out of concern that their currencies were appreciating against the euro, and officials have given the same rationale for subsequent rate cuts. If the ECB doesn’t add downward pressure to the euro in the form of rate cuts, these central banks are more likely to stay put themselves.  

Japan  

The Bank of Japan kept interest rates on hold at its April 27-28 meeting, likely due to concerns about Japanese banks, the share prices of which have dropped dramatically since negative rates were introduced. Credit Suisse’s Japan economists also note that elections for Japan’s Upper House will occur this summer, and the political environment was not supportive of a rate cut. The central bank risked turning ordinary Japanese citizens, particularly retirees, against the policy if it cut too much and raised concerns that banks could pass negative rates on to their customers.   

More importantly, Credit Suisse economists say negative rates have so far failed to have the intended effect in Japan, and may have even made economic conditions worse. All other things being equal, reducing interest rates should have the effect of weakening a currency, and yet the yen has strengthened significantly against the dollar since the BoJ implemented negative rates. A rising yen has hurt exporters, and a recent survey indicates that Japanese firms are expecting negative profit growth in 2016. Looking ahead, the recent yen rise will likely place further downward pressure on inflation. The headline CPI inflation rate was flat in February, and Credit Suisse expects it to turn negative by the end of the year.  

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Will the central bank expand quantitative easing? Not likely, says Credit Suisse, as the BOJ’s program has already been too aggressive to be sustainable. A fundamental contradiction between QE and the negative interest rate policy has also emerged. Unlike the ECB and the U.S. Federal Reserve, the BoJ’s approach to QE has been to expand the monetary base balance by a very large amount each year, which requires commercial banks to park a large amount of money at the BoJ’s reserve accounts.This kind of QE can’t occur alongside a negative-rate policy for long, as negative rates are essentially a tax on reserves.  

As such, the two facets of the country’s monetary policy are effectively working at cross-purposes. Credit Suisse believes the Bank of Japan must choose one strategy over the other, and the bank’s analysts expect the negative interest rate policy to win out over QE. Why? Because if the central bank abandons the newly introduced negative rate policy and inflation continues to decline, policymakers risk investors losing confidence in their capabilities. Abandoning or tapering QE, on the other hand, would send the message that the bank is now switching to a new regime from one that has proved rather ineffective. At any rate, Credit Suisse anticipate the BoJ’s negative interest rate to reach at least -0.50 percent by year-end.  

United States  

Could the world’s largest economy turn to negative rates? Federal Reserve Chair Janet Yellen said recently that the country’s central bank is not actively considering such a policy. In fact, Credit Suisse economists expect the Fed to raise interest rates in the third quarter – most likely in September. While recent consumer spending and inflation data have been weaker than expected, job growth has been consistently strong and Credit Suisse expects industrial production to pick up later this year.

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