Negative Interest Rates

This could be the next innovation from the European Central Bank.


While the collapse of the eurozone is now off the agenda, at least in the short term, the eurozone is still struggling with low economic growth (0.2% in the first quarter of 2014) and inflation (0.7% in April) – well below the European Central Bank (ECB) near 2% target.

After the ECB’s meeting in May, when rates were unchanged, ECB president, Mario Draghi, said that the ECB was “comfortable with acting next time.” That was widely read as meaning the ECB would be cutting rates and perhaps introducing a new range of ‘soft’ loans in early June. Quantitative easing (QE) might even follow later.

Mr Draghi’s options on the interest rate front are limited, as the graph above illustrates. The ECB base rate is already at just 0.25% and it pays eurozone banks 0% on their cash deposits with the central bank. At the time of writing, the speculation was that the ECB would make that deposit rate negative, so that banks would effectively have to pay for the security of a deposit with the ECB. Negative interest rates are not an entirely new idea, but none of the major central banks have used them before because of the difficult issues they raise. The ECB’s move – if it happens – would be designed to encourage banks to lend more, as well as depressing the value of the still-strong euro.

The ECB’s focus is in the opposite direction to that of both the US and UK central banks. The US Federal Reserve is continuing to wind down its QE programme, while in the UK the Bank of England is expecting rate rises to begin in 2015. The contrast serves as a useful reminder to investors that globalisation does not mean that all economies run in the same direction.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

27th June 2014