Every so often, a new word or phrase creeps into the vocabulary and quickly becomes part of common usage.
We’re almost there with one I doubt would have registered a year ago with most people. It’s called “negative interest rates” and it’s increasingly in the news.
The notion of interest rates below zero seems pretty crazy. Do the banks pay you to take out a mortgage? Not quite. It’s more a desperate move by central banks in Sweden, Denmark, Switzerland and the European Union to stimulate their economies.
Japan joined the club this week. Israel and the Czech Republic are almost members. U.S. regulators are asking their banks to stress test the concept.
The phrase arrived here in December, when Bank of Canada governor Stephen Poloz talked about it at the Economic Club of Toronto. In answer to a question, he said he has no plans to follow Europe’s negative-interest example, but he’ll keep it in mind.
On Friday, Japan’s central bank pushed its key rate below zero. The move is that country’s latest attempt to awaken its economy from a 20-year slump by weakening its currency and stimulating exports. In the five days since the announcement, Japan’s main stock index has fallen 2 per cent.
Here’s a primer on what all the fuss is about:
What are negative interest rates?
A country’s central bank pushes its key rate below zero. (It is currently 0.50 per cent in Canada.) In effect, this charges banks a penalty for keeping cash on hand instead of lending it out.
The move is also meant to discourage consumers from saving, while encouraging them to spend.
The real target is global business, which is sitting on a mountain of cash. Consumers have been carrying the economic ball in most countries for almost a decade. Businesses have been on the sideline. But their investments create jobs.
Is such a move likely to happen here?
Poloz says no, but also says the option is available. A big consideration is the psychological message: moving to negative interest smells of panic. People could pull in their horns and not spend, which would defeat the purpose.
What’s happened in Europe?
About a year and half ago, the European Central Bank cut its rate to below zero, and some individual countries have done the same thing. Since then, there hasn’t been much growth. Consumers try to avoid fees. They hoard cash, which has the risk of theft and fire. They pay cash, and so avoid paying taxes. Anecdotally in Switzerland, where the rate is -0.75 per cent, the wealthy have been taking high-denomination Euro notes out of their accounts and putting them in bank safety deposit boxes.
It also nudges people toward more risky investments.
Would I be charged to put money in a savings account?
No. Your bank knows that such a charge would damage its relationship with you. You will probably get a very small rate of interest over a long period to make it seem like you’re getting something. But after inflation, you would be losing money.
Negative interest rates are already here. If you keep money in a high-interest savings account, you are still losing ground after inflation. My bank pays 1.75 per cent on these accounts, while inflation in Toronto was 2 per cent in December.
What else would happen if Canada went below zero?
The consensus is that it wouldn’t do much more damage to our dollar, which has already been hit by the fall in oil prices. Borrowing rates, including mortgages, would fall a little. But how much lower can they go? This week, Meridian, Ontario’s largest credit union, announced a 1.69 per cent mortgage for a one-year fixed term.
David Watt, chief economist for HSBC Bank Canada, is among those who don’t think negative rates would mean much for housing. He believes rates have been so low that housing valuations are stretched. The strain looks even worse when you add the other things you need such after a purchase, such as furnishings and fixtures. All are more costly with a 70 cent dollar.
Why is this news now?
Central banks, like politicians, must be seen to be doing something. They’ve tried everything else and it’s not working.
“Negative interest rates are a last ditch-tool to get economies moving,” says Paul Kirk, a vice president of the Healthcare of Ontario Pension Plan. Kirk manages short-term interest rates and foreign exchange risk at the plan, one of Ontario’s largest.
In Europe, “they’re not quite throwing in the towel, but it’s really the last thing the central banks can do,” he says.
Who would such a move hurt?
Savers, the very people who have done all the right things, managing to acquire assets, being prudent. They’d be forced to take risks they would otherwise avoid.
A decade of ever-lower interest rates hasn’t revived global growth. Canada is in better shape than most countries, and stimulus spending coming in the spring federal budget is a much better way to go than ever lower interest rates.
Lower rates, including those below zero, are not something we need or want.