Once unthinkable, but it could just be the shape of things to come.....

Wednesday 11th November 2015

Once unthinkable, but it could just be the shape of things to come.....

 Ref : "Negative Interest Rates the New Normal Next Time Economies Slump" , Bloomberg Markets

With most commentators now assuming that the US Federal Reserve will start its rate-rising cycle next month, it might seem an odd time to posit the theory that in the future it might well become standard practice for central banks to implement negative interest-rate regimes in any downturn. But we need to remember that many of the world's larger economies are still running rate policies of near-zero and below, and for most of them the pressure is still for further easing.

For those long enough in the tooth to remember the 1980's for example, a scenario in which negative rates could be viewed as normal would have been considered utterly surreal. But then again anyone from that era would not have thought that long-term deflationary pressure was much of a possibility either.

Bloomberg quotes Alan Ruskin of Deutsche Bank : "There's a very real chance unorthodoxy becomes the new orthodoxy." The point Mr Ruskin makes is that if you examine the evidence from Sweden and Switzerland, where negative rates have not resulted in flights to cash, asset bubbles or banking strains, central banks have nothing to fear in implementing such a strategy when required.

Some may take a little convincing of that, and would point to soaring property values and dangerously expanding credit. The counter-argument to that would be that such problems could be dealt with through regulatory measures rather than tighter monetary policy ..... mmm, the jury will probably remain out on that one until they see such measures applied to good effect. Nevertheless it is true that the possibility of below-zero rates is no longer a no-go area for central bankers, not even for Janet Yellen of the Fed who recently revealed that in theory anything was possible if circumstances were to change.

How's it come to this ? It's a fact that interest-rate cycles shaped by economic cycles (or is it the other way around ? Discuss ...)  have been taking place at increasingly low levels for thirty years or more. In other words each has seen both a lower top rate and a lower bottom rate than the cycle that preceded it. For example, Fed Funds got to a high of 11.75% at the height of the cycle in 1984 and saw a low of 5.88% two years later. In contrast, the most recent expansion saw a top rate of 5.75% before being cut to near-zero.

Reasons why that should be the case would include such factors as the diminishing effect (disappearance ?) of inflationary pressures and a growth in savings, and certainly the next cycle looks likely to continue the trend  -- both Janet Yellen of the Fed and Mark Carney of the Bank of England have been at pains to stress that the path of rate rises will be both gradual and limited.

Whatever the arguments however, you'd have to think that  there'll be plenty who will never be confident of the benign nature of prolonged periods of negative rates ..... and given what such circumstances would say about the state of the global economy, there'll be many more hoping that we're not about to put it to the test.