David Roberts

An end to NIRP?

David Roberts

Five years ago, Sweden’s Central Bank, The RIksbank, introduced the world to a Negative Interest Rate Policy (NIRP). We had seen zero rates before, most notably in Japan, but 2015 marked the first time that a central bank decided to stimulate its economy by effectively paying people to borrow money.

The intervening period has seen a rush to copy the policy and in January 2020, the Riksbank moved rates from negative all the way up to zero.

Looking back over the last five years, it seems fair to say the impact on countries across the eurozone with a prominent NIRP has been decidedly muted. Asset prices have surged and currencies fallen (a little) but growth and inflation have remained tame – and certainly lower than the levels most developed world central banks would like to see.

In the wake of Sweden’s decision, commentators and economists have been quick to attack or defend NIRP, largely on the basis of economic impact. The debate is complex and, in truth, much more about shades of grey than black or white.

Taking the pros for quantitative easing (QE) and a NIRP first, lower interest rates should reduce savings rates, increase borrowing and push down exchange rates, leading to a growth spurt. Aggressive central bank activity (ahead of the curve) also increases market certainty and promotes consumption and investment, while charging banks to deposit with the central bank increases their propensity to lend, boosting short-term activity.

Governments can also borrow more to engage in expansionary policies while still easily servicing their debt and the cost of that servicing falls, thus increasing the return multiplier. Finally, NIRP and QE have supported asset prices and smoothed global growth, leading to the longest economic expansion on record.

On the con side of the ledger, lower rates will not depress a currency if all other central banks engage in the same policy. Meanwhile, if consumers are reliant on income from bonds and bank accounts, NIRP can act as a tax on consumption: if capital is redeployed to financial assets, the link between short-term consumption and long-term investment needs to be firmly established or else “wealth” increases but income-related consumption falls.

Confirming a shock (pushing rates way below prevailing inflation) also negatively impacts inflation expectations while depressing the cost of capital reduces the need for companies to raise prices. And last but not least, boosting financial asset prices reduces the need for corporate investment to “satisfy shareholders”, cutting productivity and destroying growth in the long term: boosting financial assets is a great way to increase wealth inequality.

Exploring just one of the above is probably going to earn a few students their PhDs.

What I want to share is the extent to which QE and NIRP, a staple tool of central bankers for the best part of a decade, is now being questioned by those same bankers.

In October 2019, for example, outgoing European Central Bank President Mario Draghi gave his farewell speech. The man dubbed by many as “the saviour of Europe” introduced QE and negative rates to Europe, successfully staving off existential threats including the ‘Peripheral Bond Crisis’ and meeting his promise to do ‘whatever it takes’.

Leaving the Bank, he noted that although low rates had served their purpose, it was perhaps time to recognise they have run their course and further heavy lifting should be done by politicians and fiscal policy.

This was unexpected and came as a shock to many. Draghi, so long the champion of aggressive monetary policy, was suggesting there may be a different path. And he is not alone: in recent months, comments from other key central bankers have started to move the NIRP debate in a new direction.

The Swiss National Bank is among those that embraced NIRP, leading bond yields to the most deeply negative level in global capital market history. But even in that bastion of capitalism, questions have been raised about the “unintended consequences” of NIRP.

Addressing the annual SNB shareholder meeting in April 2019, Chair Thomas Jordan noted that “the low level of interest rates does pose a challenge for….pension funds and life insurers and has knock on effects for the real estate market”. Despite this, however, he reached the conclusion that, in the interests of Swiss society as a whole, negative rates were appropriate.

Rather amazingly, he noted the domestic problems were caused by rates being too low globally rather than Swiss rates being to blame: “We have a thriving economy and will aggressively devalue our currency using negative rates but we don’t expect anyone else to follow,” he added.

In September 2019, Jordan again had to defend the policy. This time, he noted there were clear “negative societal impacts” from NIRP but these were still outweighed by the positives. Fast forward to January 2020 and Jordan’s colleagues said the following at Davos: “Of course we want to exit NIRP as soon as possible in the interests of society.” The subtext to this is a plea to the ECB to raise rates so the SNB can follow suit without the Franc appreciating.

Moving to the other side of the world, Governor of the Reserve Bank of Australia Philip Lowe has long been under pressure to introduce negative rates: he was recently asked by the BIS to chair a committee investigating the impact of unconventional monetary policy and the report was published in October 2019.

It is a long read but a good one for anyone interested in modern monetary policy. In short, the report notes that a “one size fits all” policy is not appropriate. Gains and losses have resulted from NIRP but the true long- term consequences are yet to be established.

Dr Lowe was a little less subtle back home in Australia. When asked whether the RBA could take rates negative, he stated “ultra-low interest rates could damage bank profitability” and keep “so-called zombie companies on life support, depressing the economy’s productivity”.

And so to 2020. Market participants had long expected Canada to cut rates but in January but they ultimately did not do so as Deputy Governor of the Bank of Canada Paul Beaudry became the latest to consider the downside of NIRP.

I’m going to paraphrase here: his speech talked, among other things, of “inter temporal trade-offs”, which sounds more Star Trek than central bank but the gist was that rates are low and things are OK so it may be time to think about tomorrow’s economy rather than today’s stock market.

In short, Beaudry said the saving the system today (using unconventional policy) meant three things:

  • It would be more likely that we had a crash in the future.
  • It is probable that crash would be deeper.
  • Ammunition to fight the crash would have been spent.

In January 2020, we had two black swan events – Iran and China – and those alone mean it is unlikely we see rates rise any time soon. Prior to the Coronavirus outbreak, macro data was pointing to a modest, accelerating global recovery even after 10 years of unbroken growth. Contrary to popular belief, inflation had risen (at the end of 2019, CPI across the G7 was above 20-year averages), so we did have some hope of a return to “normal”.

Markets and investors have grown used to the “central bank put” – that whenever things get difficult, policy will change to boost financial assets in an attempt to stimulate growth. But recent comments from leading central bankers suggest that while policy remains accommodative, we should not expect to be bailed out to the same extent again – and certainly not while the rising social impact of QE and NIRP are gaining increased attention.

To finish, the following chart highlights the relationship between G7 10-year bond yields and inflation, and shows a clear downward trend. Since 1995, investors have demanded an average income of 1.87% above inflation to lend to these governments; this number today is -1.01%.

How do bond yields now compare to inflation

Source: Bloomberg, 28.02.95 to 31.01.20

While a case could be made for this trend continuing – demographics, QE, NIRP or whatever – this misses two vital points.

First, blindly buying these bonds and holding them for the long term almost guarantees losses in real terms – there is no value for investors. And, second, if central banks do walk away from NIRP, who in their right mind will buy an asset class offering negative returns?

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Thursday, February 13, 2020, 9:50 AM