There has been some discussion in the media about New Zealand having negative interest rates.
What does this actually mean?
Negative interest rates occur when the nominal deposit interest rate (the interest rate before inflation) drops below zero.
In New Zealand, many deposit interest rates are aligned with the Official cash rate, which is set by the Reserve Bank Governor.
Currently, our Official cash rate is the lowest that it has ever been at 1%.
If the Official cash rate was to drop below zero, what would this look like?
We do have some precedents for this. Japan’s nominal interest rates went below zero in January 2016 (currently -0.1%).
Many European countries currently have negative interest rates:
- Sweden has -0.3%,
- Denmark is at -0.7%,
- Switzerland has -0.8%
- and even the European Central Bank currently has a negative interest rate of -0.4% (as of 2 December 2019)
One of the functions of the Official cash rate is that it is the interest rate that the central bank (the Reserve bank) pays banks for holding their cash overnight.
Every trading bank has a settlement account with the RBNZ, which they use for transferring money between banks on a daily basis.
As you can imagine, that account can be quite large.
If the cash rate dropped to below zero, the bank would PAY the Reserve Bank each day for the amount that it has in its settlement account each night.
This would then incentivise banks (theoretically) to lend more money, which would stimulate the economy.
Another effect will be that savings rates will go to zero, and term deposit rates will be very close to zero.
In Switzerland and Denmark, banks are now charging people to hold their money.
This incentivises people to either spend their money (to stimulate the economy) or causes them to invest their money off shore (which does not help the local economy).
Negative interest rates also affect the value of the currency, as the country becomes significantly less attractive to invest in.
Dropping the dollar will be fabulous for our exporters, but will make the general cost of living higher.
Our largest import is fuel, so the price of this will rise, and potentially will slow down our economic growth.
Mortgage rates have not gone to zero percent in Japan or Europe, although the rates are very low.
Currently mortgage rates in Japan are between 0.65% and 1% (fixed for 10 years), and there are zero percent interest rates available in Europe.
Apparently, one Danish bank did offer a negative interest rate for mortgages of -0.5%.
However, as in most things in life, there is no such things as a free lunch.
The fees for the mortgage meant that you were in fact paying a small amount for the mortgage!
Negative interest rates can damage an economy.
As mentioned before, people are likely to send money off shore to invest.
The Japanese own more assets in Australia than the Chinese do.
Having negative interest rates incentivises people to store cash, and this is common in Japan.
Taking cash out of the economy slows it down.
When Greece was threatening to leave the EU, people withdrew all of their cash from the banks and the rates of burglary sky rocketed as burglars ransacked houses looking for cash.
This is a good argument for leaving cash in the bank and paying the bank to hold it.
Negative cash rates can also distort investment markets as desperate investors flock to other income generating investments (property and shares) and distort pricing by creating small investment bubbles.
I will put my stake in the ground and say that I don’t believe that we will get into the situation of having negative interest rates.
As a New Zealander, I don’t believe that it will be good for the country.
As an investment adviser, it will create so much work for us that we will be working 7 days a week with people seeking actual investment returns. Hmmmm…..every cloud has a silver lining!