Negative US And UK Interest Rates?

Negative US And UK Interest Rates?

almost 4 years ago2 mins

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Markets may be anticipating central banks in both the US and UK shortly introducing negative target interest rates – but as investment bank Morgan Stanley points out, such a move could prove counterproductive 🙃

What does this mean?

Both the Federal Reserve and the Bank of England have responded to the coronavirus crisis by slashing base rates to near zero – while insisting that they have no plans to go any lower. But that hasn’t stopped investors in recent weeks betting that borrowing costs will fall further, reasoning that in this environment, anything is possible. While attracting the US presidential seal of approval, however, negativity is by no means a certain solution to economic malaise.

The idea is that negative interest rates, by making saving money a losing proposition and borrowing it a winning one, encourage people to spend__ thereby boosting economic growth. But as Morgan Stanley points out, economies which have previously tried this approach – such as Japan and the eurozone – have largely failed to reap the expected benefits.

The eurozone recently cut rates further (Source: Toptal)
The eurozone recently cut rates further (Source: Toptal)

Not only are there practical drawbacks to negative rates messing with the plumbing of the financial system, but they’re also deeply unpopular. In reality, banks struggle to pass on the costs to customers – and swallowing these themselves may make the banks more reluctant to issue new loans, inhibiting economic growth 😖

Why should I care?

If the US and UK do roll out negative base rates, and cash-strapped banks do manage to implement them, then savers can expect to be penalized – not least because a cheaper cost of borrowing would potentially push up the prices of things you might be saving up for, like a home. And if that encourages people to save more, then growth may again suffer.

Falling inflation increases the pressure on the US and UK to take further action (Source: Statista)
Falling inflation increases the pressure on the US and UK to take further action (Source: Statista)

Morgan Stanley thinks central banks are well aware of this vicious circle, however – and that markets’ expectations of negative rates will therefore be disappointed. For investors who agree, that mismatch could create an opportunity to profit by banking on short-term government bond yields rising… 👀

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