Negative interest rates are exactly what they sound like – depositing money actually attracts a charge rather than earning interest.
The idea of this is that the banks will not deposit any more than necessary with the Reserve Bank and instead will lend the money, or invest in more profitable activities with a higher return.
Instead of earning interest on money left with the central bank, banks are charged by the central bank to park their cash with it and the hope is that this will encourage the banks to stop hoarding money, and instead lend more to each other, to consumers, and to businesses, in turn boosting the broader economy.
What does this mean for bank customers?
It depends on the bank.
It might lower or charge its own negative interest rates, keep them the same and eat the loss, or charge interest indirectly through higher deposit fees.
Commonwealth Bank chief currency strategist Richard Grace estimates that there will be €124 billion of excess liquidity (cash) as a result of the negative interest rates move in Europe.
This gives banks three options: lending the money into the economy (which the ECB wants), parking it in interest-paying German bonds or French bonds, or shuffling it into higher-yielding assets such as the Aussie dollar.
Grace stresses that it’s the commercial banks that decide whether to pass on the negative interest rates on to their customers.
Switzerland is one country where the central bank briefly introduced negative interest rates on deposits and commercial banks followed suit.
While the negative rates have grabbed the headlines, it’s this attempt to push down interest rates right across the economy that means the “refi” rate cut is actually the most important measure announced.
Will it work?
No one knows.
In theory it sounds attractive but it has never been attempted by the Central bank of Europe and could have unpredictable and unintended consequences.
Those consequences include the possibility that banks will pass on to customers the costs they incur for depositing money with the Central bank.
A broad risk is that a negative return on parking funds with the central bank might encourage banks to invest in riskier assets to secure a return, potentially driving new asset bubbles and more pain further down the line.
As part of this bid to find alternative investments, banks are likely to increase their purchases of government bonds.
However, this has potentially serious consequences if banks are holding bonds to such an extent that government borrowing costs are artificially low.
If a financial shock occurs, the banks and governments could find themselves so intertwined and interdependent that they drag each other – and the economy – down.
What would it mean for me?
In Australia I believe very little in terms of any impact on retail banking rates, however negative rates have a tendency to relieve pressure on a country’s currency.
The Aussie dollar is sitting around US75c again and Australia’s 2 per cent cash rate remains steady.
The Reserve Bank has a policy of maintaining a lower Dollar and it has the room to cut interest rates further.
But concerns of extending and re stimulating the housing bubble would mean interest rate cuts are unlikely.
Europe and the US have the policy of negative interest rates and this means that the Aussie dollar looks set to remain high and may continue to go up, meaning an impact on our local economy and competitiveness