How are market expectations panning out for negative rate cuts?

Coronavirus pandemic has shaken the global economy through its exponential spread leading to turbulence in financial markets, falling bond yields, shutting down businesses and halting economic activity across the globe. Anticipating the economic impact of the virus is difficult, given the uncertainty of the virus and scarcity of similar events that could give any guidance.

IMF has predicted that the world output will contract by 3% in 2020.

The growing concerns over the global economic impact of the pandemic forced countries to go for interest rate cuts and use appropriate policy tools to sustain economic growth by smoothening the credit flow across businesses and households. The government took fiscal support initiatives to help their health systems bear the burden and help people who have been financially affected because of coronavirus.

Interest rates are the levers central banks use to adjust monetary policy and maintain money supply in the economy based on economic indicators like inflation, recession and other things that can affect economic growth. Central banks raise interest rates to protect the economy from inflation to reduce credit in the hands of consumers and lower the interest rate at the time of recession to encourage credit flow amongst borrowers and increase spending in the economy.

Let's have a look at the interest rate cut decisions taken by various central banks so far-

Source: Respective Central banks

Source: Respective Central banks

The Federal Reserve: The Fed reduced its interest rates by 150 bps in March to 0-0.25%. The bank also expanded overnight repo rates, lowered the cost of discount window lending and broadened US dollar swap lines with other central banks. It has infused $2.3 trillion into the US economy through emergency schemes of extending credit to a small and medium-sized business, purchasing corporate bond ETFs and municipal bonds.

Reserve Bank of Australia: RBA reduced its cash rate by 25 bps on March 3 and reached to 0.25% on March 19. It also took measures to target yield on 3-year government bonds at 0.25% through government bond purchases. It also conducted 1-month and 3-month repo operations daily to support liquidity.

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Bank of England: The bank reduced bank rate by 65 bps to 0.1% and expanded its holding of UK government bonds and non-financial corporate bonds by £200 billion. It also introduced a new Term Funding Scheme to support the transmission of the rate cut.

Reserve Bank of New Zealand: RBNZ cut its official cash rate by 75 bps to 0.25% on March 17 and carried out a Large-Scale Asset Program to buy government bonds up to NZ$30 billion across a range of maturities in the secondary market. It also introduced the Term Lending facility at 0.25% for up to 3 years.

ALSO READ: COVID-19 Epidemic: Global Rate Cuts; OECD Downgrades Economic Growth Forecasts

Bank of Canada: It reduced its overnight policy rate by 150 bps in March to 0.25%, extended it buy-back program across all maturities, launched Bankers' Acceptance Purchase Facility and expanded the list collateral for Term Repo operations.

Bank of Russia: CBR (Central Bank of Russia) cut its policy rate by 50 bps to 5.5% on April 24 and started selling forex reserves from the National Welfare Fund on March 10. The CBR has temporarily introduced a long-term refinancing instrument.

Case for negative rate cuts

Negative rates mean falling of interest rates to below 0%. Negative interest rate is a phase where central bank pays to banks for their deposits or reserves with it. Banks are obligated to preserve a minimum balance of reserves with the central bank according to the amount of deposits they hold. They can maintain a larger balance than the required minimum called the excess reserve.

A negative interest rate results in the interest paid on the excess reserves to turn negative or drop below 0. In such a situation, banks pay the central bank to keep their money and hence, incentivising banks to lend funds instead of keeping it as reserves. Negative rates tempt people to borrow more, since interest rates on loans get reduced and push people away from holding cash in the bank. Hence, they help in fighting deflation, i.e. when people spend less, and prices of goods drop.

ALSO READ: Central Banks Draw Rate Cut Card to Spur Demand as World Grapples COVID-19, Commodities to Shine?

European Central Bank and Bank of Japan have cut their benchmark interest rates below 0 to push banks to give loans and stimulate growth; the policy has been criticised for driving away financial institution's profits and discouraging them from lending. Similarly, Denmark, Sweden and Switzerland that have used negative rates have struggled to control the reactions from banks and savers.

European Central Bank adopted its first negative interest rate policy in 2014 when it lowered its interest rate to -0.1% to address the euro crisis. At present, the ECB deposit rate stands at -0.5%.

Bank of Japan was the first central bank to adopt a 0-interest rate policy in 1999 and has been on negative rates since 2016.

In Japan and Europe, negative interest rates have upset the banking sector where banks are the principal credit foundation for many companies.

Market Expectations

Investors have been betting recently that The Fed will bring down rates to negative territory after they saw some big US banks going for hedging to protect them and their clients against the risk. Investors in the futures market have started to bet on negative rates despite the Fed's assurances.

US President Donald Trump asserted last week then negative interest rates would be a gift to the economy.

However, Fed Chairman Jerome Powell and other officials have strongly resisted the idea. Several Policymakers feel the same stating that stress on banks and the US dollar's role globally push away the case of negative interest rates.

RBNZ’s Assistant Governor, Christian Hawkesby stated, “RBNZ is also contemplating negative cash rate due to uncertainty caused by coronavirus pandemic and downside risks to the economy.”

He added that BOJ and ECB had got a bad rap as they didn't get inflation on target even after employing negative rates for long but asserted that they didn't deserve it as consequences could have been much worse if the step was not taken.

Mr Hawkesby stated that an uncertain environment, there is not much advantage from ruling out tools that can be used in future. Some economists have pushed on the need for negative rates in NZ for the needed stimulus while some have warned that it could trigger asset bubbles and restrict credit growth.

Understanding the need of finance for businesses through the banking system, BOJ and ECB have lessened collateral obligations for the banks that use their loan programs and have started rewarding banks for lending or for borrowing in the case of ECB giving a new variation in negative interest rates policy.

The present situation requires massive investments for restructuring with a need for extended borrowing by many businesses where negative rates could be looked upon as lesser evil. However, there has been an increasing agreement among central banks worldwide that negative rates have massive downsides and mixed positive outcomes.

(NOTE: Currency is reported in Australian Dollar unless stated otherwise)





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