Look – European Banks Have Negative Interest Rates | Pete Wargent

Boy have times have changed

The European Central Bank (ECB) announced last night that it was cutting its interest rate to just 0.15% from 0.25%, and cut its deposit rate to negative i.e. banks will be charged money to deposit funds overnight with the bank.

The ECB is concerned about the the threat of deflation and sagging economic growth, and will consider extraordinary measures to combat the threats, including quantitative easing (QE).

There have been a number of interesting articles overnight discussing the implications of negative interest rates.

Deflation is a threat

Deflation, where households postpone spending plans indefinitely as they expect the cost of goods to keep falling, is the negative death spiral feared by central banks.

Meanwhile, the Bank of England left its base rate on hold yet again at 0.50% where it has beensince March 2009.

The Bank of England’s decision was taken in spite soaring house prices, with the Halifax House Price Index reporting that dwelling prices have jumped by a vaguely ridiculous 3.9% of £7000 in a month.

Clearly that didn’t happen, but what is certainly the case is that house prices in London and the south-east are threatening to get out of control.

A new era

For years now a number of developed countries have been running an effective Zero Interest Rate Policy (ZIRP) in order to stimulate economic growth and combat the threat of deflation.

Are we now heading for Negative Interest Rate Policies (NIRP)?

In fact, with an official cash rate of 2.50%, Australia now looks to have a relatively high interest rate, although it is of course remarkably low in historic terms (click chart):

Neutral rate is much lower

There are plenty of articles and opinions around which take the line that Australia’s housing markets will be in for some trouble when the Reserve Bank hikes interest rates “back to normal” at around 7% or so.

Question the underlying assumption, though.

This is not to say that we won’t get back there one day if inflationary days return, but for the reasons I explained in this piece here, a “neutral” cash rate in today’s era of higher household debt might even be somewhere closer to half of that figure:

“With the proviso that there must be an element of intuition employed, I’d estimate that today that number for a neutral rate would be in the 3.75%-4.25% range.

Why?

Partly because of the strong Australian dollar which can artificially cause lower growth.

 Partly because household debt levels are higher than they used to be, and thus each movement or adjustment in the cash rate is likely to affect consumer intentions more than was the case in times past.
Another factor still is that bank lending spreads have increased again…”
 Read the rest here.

Yesterday’s announcements saw the Aussie dollar jump all the way back above 93.3 US cents, adding further weight to the case for potential interest hikes now having disappeared over the horizon.

If there’s one thing we don’t need in Australia at the moment, it’s an Aussie dollar heading too high again.

Rates heading lower still?

I  wrote 7 months ago that it would likely be ongoing low interest rates for 2014 (and possibly even lower interest rates) and not a lot has changed in that time to change that viewpoint.

This week’s GDP result for the first quarter illustrated the challenges perfectly: economic growth is now being driven overwhelmingly by mining production, so if the boom in net exports stumbles either in terms of bulk commodity volumes or commodity prices, the rate cutting cycle may soon resume.

Neither household consumption nor housing construction has been contributing significant growth to GDP, suggesting that more cuts may yet be needed if net exports do not continue to soar (click chart):

 

I note that a number of experienced commentators has opined that Australia will eventually be forced to join other developed countries with a cash rate of close to zero.

Perhaps it’s just that we are taking a long, slow march to zero rather than diving there as other countries did during the financial crisis.Certainly futures market have given up the ghost on pricing in hikes any time soon.

The next interest rate adjustment might just as likely be down as up :

[post_ender]


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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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