Negative interest rates may backfire, economists warn

Hard to predict behaviour if rates fall further below zero or stay negative for long run: BIS

LONDON • Economists from Bank for International Settlements (BIS) have warned that negative interest rates may backfire on European and Japan central banks the longer and deeper they venture into this unconventional monetary policy.

The warnings come days before a European Central Bank (ECB) meeting on Thursday, at which the bank is expected to push more into negative territory - lowering the deposit rates by 10 basis points into minus 0.4 per cent - to stave off deflation.

BIS, in a research paper published last Sunday, said it is difficult to predict how individuals or financial institutions would behave if rates fall further below zero or stay negative for a long period, Financial Times has reported.

It was unknown, BIS said, how borrowers and savers would react or whether the channels through which central banks' rate moves are usually passed on to the broader economy would "continue to operate as in the past".

The economists also warned that the policy could have serious consequences for the financial sector. Banks have so far taken the brunt of negative interest rates, and have not passed on most of the cost of the cuts to their customers. "The viability of banks' business model as financial intermediaries may be brought into question," the research stated.

Policymakers have used negative rates as a tool to raise low inflation, but critics dub it a short-sighted attempt to weaken currencies. Financial investors are also critical, arguing that banks are having to foot too much of the bill for the experiment.

The ECB and the Bank of Japan (BOJ) are the biggest central banks to have taken rates negative. Others include Sweden's Riksbank, which cuts its main repo rate last month to -0.5 per cent, and the Swiss central bank, which has lowered rates to -0.75 per cent.

"If negative policy rates do not feed into lending rates for households and firms, they largely lose their rationale," said BIS economists Morten Bech and Aytek Malkhozov. "On the other hand, if negative policy rates are transmitted to lending rates for firms and households, then there will be knock-on effects on bank profitability," they were quoted by FT.com as saying.

There are doubts whether negative rates work - the BoJ's surprise move into negative territory halted the yen's appreciation only for a matter of days.

BOJ Governor Haruhiko Kuroda said yesterday that the bank's negative rate policy would do a lot to lower interest rates and lending costs.

However, he told the Upper House Budget Committee that he is not currently thinking of taking additional steps to ease monetary policy, according to Reuters.

Mr Kuroda reiterated his view that in the future he is prepared to adjust monetary policy if needed.

A version of this article appeared in the print edition of The Straits Times on March 08, 2016, with the headline 'Negative interest rates may backfire, economists warn'. Print Edition | Subscribe