Negative interest rates are distorting markets
Once upon a time, we all thought that the lowest interest rate could possibly go was zero. However, the actions of European central banks have thrown this assumption on its head. Fifteen percent of global sovereign bonds are now trading with a negative yield. These extremes are creating strains and distortions, including in New Zealand’s financial markets.
In the 1990s, following the Japanese sharemarket and property crash, the Bank of Japan cut interest rates, and instituted their so-called ‘zero interest rate policy’ (ZIRP). At the height of the GFC in 2009, the US and UK stopped just short of zero, leaving overnight interest rates at 0.25% and 0.5% respectively. Quantitative easing (QE) programmes were designed to bring down longer-term bond yields.
In recent months, the boundaries of central banking have been tested once again, with the ECB, Swiss National Bank, National Bank of Denmark, and the Riksbank (in Sweden) all setting overnight interest rates below zero. Indeed, German and Swiss government bonds are trading with negative yields to maturities beyond 5 years.
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Frequently Asked Questions about this Article…
Negative interest rates occur when central banks set their overnight interest rates below zero. This means that instead of earning interest on deposits, investors might actually have to pay to keep their money in the bank. This can distort financial markets and affect investment decisions, as traditional safe investments like bonds may no longer provide positive returns.
Central banks, such as those in Europe and Japan, are implementing negative interest rates to stimulate economic growth. By making borrowing cheaper, they hope to encourage spending and investment. However, this unconventional policy can lead to market distortions and challenges for investors seeking returns.
Negative interest rates can lead to negative bond yields, meaning investors might receive less money back than they initially invested. This is because the price of bonds rises as interest rates fall, and when rates are negative, the yields can also turn negative, affecting the returns for bondholders.
The Zero Interest Rate Policy (ZIRP) was first implemented by the Bank of Japan in the 1990s to combat economic stagnation. It involves setting interest rates close to zero to encourage borrowing and investment. Negative interest rates are an extension of this policy, pushing rates below zero to further stimulate the economy.
During the Global Financial Crisis, central banks in the US and UK lowered interest rates to near zero to support the economy. This was part of a broader strategy, including quantitative easing, to reduce longer-term bond yields and encourage economic recovery. These actions set the stage for the negative interest rate policies seen today.
Countries with central banks that have implemented negative interest rates include those in the Eurozone, Switzerland, Denmark, and Sweden. These policies are part of efforts to boost economic activity and combat deflationary pressures.
Negative interest rates can create market distortions, making it challenging for investors to find safe, positive-return investments. They may also lead to asset bubbles as investors seek higher returns in riskier markets, potentially increasing financial instability.
New Zealand's financial markets are experiencing strains due to the global trend of negative interest rates. These rates can influence capital flows and investment decisions, impacting the country's economic stability and financial market dynamics.
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