The clearest example: the Bank of Japan’s January 29 decision to apply negative interest rates to a small portion (4 percent) of commercial bank reserves. “The intended signaling was that quantitative easing could still be expanded and that the commitment to raising inflation remains strong,” analysts in Credit Suisse’s Global Markets division wrote in a recent report. “For us, the bigger message is that policymakers are not finding traction in combating lackluster growth and are struggling in the search for effectiveness without any real conviction.”
In Europe and Japan, commercial banks have refrained from passing negative rates on to depositors and customers, offering little incentive for households and businesses to save less and spend more. That said, negative interest rates are also designed to encourage banks to lend, and the latest European bank lending survey indicates that the combination of quantitative easing and negative interest rates have resulted in looser credit standards on bank loans to both households and businesses, as well as higher demand for consumer credit, mortgages, and business loans. In addition, Europe has to date had a strong, consumer-led recovery, meaning there is some appetite for borrowing. In Japan, however, consumption has been relatively weak for the past year, and it’s too soon to know whether negative rates will change that.
Credit Suisse’s Japan economists believe the Bank of Japan’s main goal in introducing negative interest rates was to moderately weaken the yen or at least prevent it from strengthening, but currencies do not always respond to central banking intentions. Indeed, since the BoJ introduced negative rates, the yen has strengthened some 9 percent from ¥118 to the dollar to ¥108 in mid-April. The euro, too has strengthened 3.7 percent from €0.91 to the dollar to €0.88 since the European Central Bank cut rates further into negative territory on March 10.
There are two likely reasons for the market’s reaction – or lack of reaction – to those policy moves. First, each new central bank surprise has less impact than the last – as Credit Suisse puts it, “the novelty factor and perceived benefits” of monetary easing are declining. Second, China’s growth slump and plunging oil prices have pushed interest rates lower around the world in 2016, eliminating the spread widening that usually makes foreign exchange carry trades attractive after a rate cut. Some 30 percent of sovereign bonds in the developed world are now trading at negative rates.
Yields on 5-year German bonds have dropped considerably since the ECB lowered rates further into negative territory, from -0.236 percent on March 10 to -0.395 on April 11, but so, too, did the yields on five-year Treasuries, which dropped from 1.45 percent to 1.16 percent as turbulence in global financial markets sent investors running back to the safety of sovereign credits, particularly U.S. Treasuries. And the spread between European and U.S. interest rates actually narrowed from 1.686 percentage points to 1.555, removing downward pressure on the euro.
The same effect has occurred with Japanese debt. Despite yields on five-year Japanese government bonds dropping from 0.017 before the negative rate announcement to -0.224 on April 11, Credit Suisse also sees little room for capital outflows. For one thing, the largest destination for Japanese foreign investment is emerging Asia, which has had troubles of its own lately, and Japanese investors were already cutting exposure to foreign assets when the central bank announced negative rates.
Apart from its effect on the yen, Credit Suisse’s Japan economists believe the Bank of Japan’s negative interest rate policy will work against its quantitative easing program, through which it buys Japanese sovereign bonds from commercial banks. If those same commercial banks can expect to receive negative interest rates on the cash they receive from the BoJ, they’re likely to hold on to their bonds, which at least pay some interest. As for the ECB, the bank may already be shifting away from negative interest rates as a policy tool, preferring instead to ease credit conditions. The central bank lowered its deposit rate just 0.1 percentage point to -0.4 percent in March, but also introduced a generous financing program that allows commercial banks to borrow at a negative interest rate – essentially getting paid to borrow – as long as they step up their own lending to households and businesses.
One thing Japan’s policy could do, however, is encourage other countries to move into negative territory – and in fact, it may already have done so. Hungary’s central bank cut rates into negative territory on March 22. Japan’s neighbors also seem poised to ease further, even if outright negative rates are unlikely. Taiwan cut rates in March, and Credit Suisse says South Korean policymakers will likely follow suit if external demand continues to slow or domestic demand falters.
If that domino effect materializes, global monetary policy could start looking like a race to the bottom—and not an entirely unsurprising one. Since the financial crisis, central bankers have been left almost entirely on their own to stimulate growth, with politicians loath to commit to significant, long-term fiscal stimulus. But it’s becoming increasingly clear that central banks cannot conjure up demand on their own and that there are diminishing returns to additional easing. At this point, fiscal stimulus—whether it is in the form of tax cuts or increased spending—would be a more effective shot in the arm for growth than increasingly desperate monetary policy.
Source: https://www.thefinancialist.com/
