What happens when deposit rates go negative?
What do negative interest rates mean to your pocket? That question could be raised as early as next month when the European Central Bank is expected to cut rates again.
The ECB needs to keep stimulating the European economy and it is likely to do so with a cut of 10 to 20 basis points (0.1pc-0.2pc) at its June meeting.
But its main refinancing rate, the benchmark for mortgages, is already down to 0.25%. The rate it charges banks for overnight deposits is as low as 0%.
Any significant across-theboard cuts would take us into negative territory.
A cut of 0.2% would leave the main rate barely above zero while the bank deposit rate would be -0.2%.
This means the ECB would charge banks for depositing funds, a move designed to encourage them to lend more. However, the refinancing rate is more significant to borrowers and savers and this should remain positive – just about.
The big winners would be lucky tracker mortgage holders. Tracker mortgages track the ECB refinancing rate. On average, they remain around 1.1% above it.
With a cut of 20 basis points, the main ECB rate would fall to 0.05%, which would bring the average tracker rate to just 1.15%, just a quarter of the typical mortgage rate.
Repayments on a €200,000 average tracker mortgage would be just €767 a month.
That compares to the €1,100 monthly bill at a more normal 4.4% borrowing rate.
It gets worse for nontracker borrowers. They are unlikely to get the benefit of any rate cut, because banks will charge them more to subsidise losses on trackers.
Savers will also lose out, but there are still havens for smart money.
One is a regular savings account, which currently can pay up to 4% (with Nationwide UK (Ireland)).
Another is An Post’s range of tax-free savings products.
Five-year Savings Certificates pay 2.11% a year, tax-free. Also worth a look are Instalment Savings plans, which pay 2.41% tax- free. These still look like pretty low rates. But at least inflation is rock bottom at 0.4% so savers are still making money.
How low can interest rates go? The US central bank – The Federal Reserve – has kept its main rates hovering barely above zero for some time. But a report by two of its senior bankers has warned of the bizarre implications of dropping into negative territory.
It painted a picture of an economic world turned on its head with people penalised for putting money in the bank. Their report envisaged a world where:
Special banks would charge to hoard vast amounts of cash in vaults;
Large-denomination banknotes would be needed to make hoarding money easier;
Cheques would make a comeback with payees keeping rather than cashing them;
Taxpayers would overpay tax in order to store money for free and reclaim it later;
People would lodge money into credit card accounts before spending it.
The report concluded that sustained rates of minus 0.5% or less would lead to an ‘epochal outburst of socially unproductive financial innovation’.
It warned that regulators and financial systems may not be able to cope with the new risks spawned by negative rates.
Not surprisingly, in the light of this report, The Fed has yet to send its rates below zero and it’s unlikely that Fed chief Janet Yellen would favour such a move.
The report is also likely to discourage the ECB from dropping its rates too far.
So don’t rush down to the bank just yet to withdraw your savings and hide them under the mattress!
If Interest Rates Go Negative….Or Be Careful What You Wish For, by Kenneth Garbade and Jamie McAndrews (2012). See full report on http:// libertystreeteconomics. newyorkfed.org/.