Negative rates are here to stay as debt levels ramp up
IF it was a shock last week when Bank of Ireland announced it would start charging small and medium companies to hold funds on deposit, it should have not have been a surprise.
It appears more likely that not that there will be more similar announcements.
With governments racking up spending and debt at an unprecedented rate in response to the coronavirus pandemic, central banks across the world are going to be called upon to keep a lid on interest rates long after the initial shock is over – for fear of triggering a debt crisis.
The longer interest rates are in negative territory, the more pain that inflicts on bank profitability, and so there will be a greater need on their part to pass on costs.
The European Central Bank (ECB) has had negative interest rates since 2014 in a bid to revive the ailing eurozone economy and cut them further to minus 0.5pc last September, with an allowance against funds it requires to be held on deposit.
That was before the pandemic hit, plunging the eurozone into the sharpest and deepest recession it has ever experienced and prompting a massive rise in spending.
The International Monetary Fund’s most recent estimate is that gross government debt across the ‘rich world’ will rise by $6 trillion (€5.1 trillion) to $66 trillion at the end of this year, more than in any year during the global financial crisis.
That begs the question of what happens to this mountain of debt once the economic life-support measures put in place for the pandemic come to an end.
The best outcome would to repeat the strong economic growth seen here since 2014, but that is going to be a hard trick to repeat.
A second round of austerity in a decade is too damaging to contemplate while tax rises will run into opposition.
That leaves the ‘fudge it’ option of relying on the ECB to continue to do the heavy lifting by keeping a lid on interest rates.
It has worked before. At the end of the Second World War, the ‘rich world’ was in hock to the tune of 100pc of gross domestic product (GDP).
By 1970 that figure was 20pc thanks to ‘financial repression’ which mean capping interest rates and putting pressure on savers to lend to the government by making it hard to move your money around.
Banks are already forced to hold larger amounts of government debt and the ECB is capping rates – closing the premium investors demand for holding risky debt like Italy’s.
The bank has already announced pandemic response measures that will see it buy €1.5 trillion of eurozone bonds on top of the €2.6 trillion it already owns.
Clearly, the ECB and the eurozone will not want to see all those extra trillions in pandemic spending turn into a ticking debt time-bomb.
“While central bank bond purchases are currently warranted, given the economic backdrop, we believe that they will be used to buy time for vulnerable countries, even if economic conditions do not justify further balance sheet expansion,” economists at investment bank Barclays wrote in a recent analysis.
That means negative rates are going to spread through the financial system here.
IMF says rich world’s debt will hit a record $66 trillion this year