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The World Experiments with Negative Interest Rates

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Below Zero


By Dan Timotic CFA

As of late April 2016, six central banks in Europe and Asia have adopted negative interest rates in an effort to stimulate their national economies. The experiment began in Denmark in 2012, but the big step came in June 2014 when the European Central Bank (ECB) dropped its benchmark rate below zero. Sweden and Switzerland soon followed, and Japan and Hungary went negative in early 2016. Taken together, these economies represent about one-fourth of global economic output.1–2

Although the Federal Reserve remains committed to raising the federal funds target rate, the Fed is watching the efforts of foreign central banks with an eye toward expanding its tools in the event of an economic downturn. On a more immediate level, the overseas experiment is affecting the dollar and helping to suppress interest rates in the United States.3–4

Reverse Economics

Central banks lower interest rates for two fundamental reasons: (1) to encourage business investing and consumer spending by making it cheaper to borrow and less lucrative to hold onto cash; and (2) to lower the value of the national currency in order to make exports more appealing and create an expectation of future inflation, which may further stimulate current spending.

The push into negative territory reflects the same goals, but it reverses traditional economic concepts by turning borrowers into creditors and creditors into borrowers. Although specifics vary, the central banks are pulling rates downward by assessing a negative interest rate on certain short-term deposits from commercial banks. These banks actually lose money on their deposits, which in theory should stimulate the banks to lend money to other banks, businesses, and consumers.

The greatest fear regarding negative rates is a mass exodus from the banking system. The experiments in Europe and Japan are still new and the rates relatively moderate, but so far banks and their customers seem to be weathering the transition, albeit with lower margins and additional fees.5 Deposits in eurozone banks grew by $327 billion from June 2014 (when negative rates were implemented) through October 2015.6 Some banks assess negative rates on large commercial customers, but they have been hesitant to do so with retail customers. One small Swiss bank instituted a charge of 0.125% on savings accounts and gained more customers than it lost.7

These early responses suggest that businesses and consumers may be willing to pay a premium to deposit cash assets safely in a bank. Keeping large amounts of cash outside of a bank can be expensive, requiring guards, safes, and other security measures. Average consumers might keep cash under a mattress, but it is difficult to pay bills — or buy merchandise over the Internet — with cash. This cost-benefit balance may change if rates continue to decline.

Bonds and Mortgage Rates

By April 2016, more than $8 trillion of government bonds in Europe and Japan were trading at negative interest rates.8 As with banking, this suggests that some investors are willing to accept a loss in return for the security of government bonds. However, negative or very low yields may put pressure on pension plans and insurance companies, which depend on low-risk, fixed-rate investments.9

Low rates have driven housing prices up in Denmark and Sweden, creating fears of a “bubble.” Some Danish homeowners have even seen the monthly interest on their adjustable-rate mortgages turn into monthly credits due to negative rates.10




Currency Competition

After the ECB instituted negative rates, the euro dropped sharply against the U.S. dollar and was still down about 17% in April 2016.11 A strong dollar stimulates European exports at the expense of U.S. exports and makes it more difficult to raise U.S. interest rates, which would only make the dollar more appealing for foreign investors.

Denmark, Sweden, Switzerland, and Hungary all dropped rates in large part to keep their currencies competitive with the euro.12 Denmark’s experience, the longest-running experiment, suggests that negative rates may be effective when the primary goal is to control currency but less effective as a stimulus to growth.13 On the other hand, Japan’s initial efforts have seen the yen rise unexpectedly against the dollar, unsettling markets.14

How Low Can They Go?

Early eurozone results are tepid but encouraging. Annual GDP growth improved to 1.5% in 2015 versus 0.9% in 2014, and lending by eurozone banks (which had been decreasing) increased slightly by 0.6% in 2015.15 It’s unclear how much worse the European situation might be without negative rates.


After a tentative beginning, central banks have become more aggressive. In March 2016, the ECB dropped its deposit rate to –0.40%, and the Swiss National Bank rate was –0.75%.16 It remains to be seen how banks and consumers will respond to even lower rates, and whether reverse economics will strengthen the global economy or create new challenges.

All investments are subject to market fluctuation, risk, and loss of principal. Investments, when sold, may be worth more or less than their original cost. Investing internationally carries additional risks, such as differences in financial reporting and currency exchange risk as well as economic and political risk unique to a specific country. This may result in greater investment price volatility.


1, 5, 9, 16) International Monetary Fund, 2016 2, 12) Reuters, April 10, 2016 3) The New York Times, March 5, 2016 4, 11) European Central Bank, 2016 6) The New York Times, December 3, 2015 7–8, 10, 14) The Wall Street Journal, April 14, 2016 13) Bloomberg, February 15, 2016 15) The Wall Street Journal, February 28, 2016


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6 Responses

  1. More on NEGS

    Negative interest-rate policies adopted by several central banks in Europe and Japan have driven a significant amount of global government bond yields into negative territory.

    It started about two years ago, when the European Central Bank (ECB) took the unprecedented step of lowering its key interest rate below zero. The ECB hoped that, by charging banks to deposit money with the ECB, they would instead put the money to work by lending to businesses and consumers. Earlier this year, Japan followed suit.

    For an investor, a negative yield to maturity means that the interest and principal payments that the investor collects as the bond matures are worth less than the current price of the bond.

    But, it’s a bit more complicated for U.S.-dollar-based investors because a portion of the return of an international bond can come from its associated currency exposure. This exposure can be partly neutralized through hedging, which can make the “currency-adjusted yields” of international bonds look similar to comparable yields of domestic bonds.

    Currently, for U.S. investors, hedged international bonds would have positive “currency-adjusted yields,” while European and Japanese investors would face negative “currency-adjusted yields” when hedging.

    International bonds can provide important diversification benefits, and they are the world’s largest asset class, representing nearly one-third of the global capital market’s value. International bonds are driven by some factors that are relatively different from those that drive U.S. bonds. For example, global central banks’ monetary policies have diverged, as the Federal Reserve began raising rates while many others have done the opposite. Differences in economic policies, inflation, and growth can translate into differences in interest rates across countries.

    So, some hedged international bonds can play a role in a diversified portfolio and can serve as a counterweight to stock market volatility.

    Dr. David E. Marcinko MBA


  2. NEGS

    Earlier this week, the U.S. Treasury 10-Year Yield reached a record all-time low of 1.32%. Investors in U.S. Treasuries bonds (0-10 years’ maturity) are now losing money when adjusting for inflation. Comparatively, U.S. stocks currently yield around 2% in dividends annually.

    The phenomenon of low rates has been even more exaggerated in Europe than in the United States. Germany, Switzerland, Denmark, Sweden all currently have negative interest rates.

    Essentially, investors in these countries may be forced to pay cash just to hold money in the bank. In the most extreme of these cases, the Swiss 3-month Libor rate was at -0.8% as of late June! We also saw record-lows in France and U.K.

    Patrick Bourbon CFA


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