Research Team at NAB, suggests that whether and how negative rates work to lift activity and inflation is currently a matter of great uncertainty and debate. Key Quotes “Much depends on the extent and length of time to which central bank policy rates can be moved into negative territory and the degree to which they are allowed to flow into retail deposit and lending rates. Impact on retail rates - If retail deposit rates stop at the zero floor and banks stop passing cuts into lower lending rates, that blocks off one of the major transmission mechanisms of monetary policy – borrowers spending power is no longer affected. Commercial bank willingness to lend – negative deposit rates were designed to dissuade banks from piling up funds at central banks and instead lend the money out to their customers. The ECB has brought in a carrot to accompany that stick to lift bank lending – it will lend banks money for 4 years at a price scale stretching from its refi lending rate (now zero) to its deposit rate (now -0.4%) provided those banks lift their lending to private non-financial sector customers. This is uncharted territory but the use of the carrot could have more impact on banks than the stick. Depreciate your currency and beggar your neighbours - Negative policy rates flow into lower money market and long bond rates, affecting bank wholesale funding costs and driving the exchange rate down. The Swiss and Swedish currencies have not appreciated against the Euro, despite Euro weakness and that could well reflect negative rates holding down their currencies – chart opposite. Bank of England Governor Carney has been critical of negative rates as a way to lift activity, saying it relies heavily on currency depreciation that boosts the local economy at the expense of its partners and harming the global economy. Bank of Japan Governor Kuroda disagrees – saying that share prices rose and money market rates fell after Japan’s move to negative rates, already low retail deposit rates were cut even further, real interest rates declined across the entire yield curve and all that should boost activity. Previous moves toward negative rates did keep currencies down but the yen rose after Japan made the shift – leading critics to say that even the “beggar thy neighbour” currency depreciation rationale for negative rates was ineffective, so the policy was a failure. Kuroda’s reply is that the yen’s appreciation reflected the safe haven role of the yen in a period of global financial market volatility and was nothing to do with the introduction of negative rates, which were still effective in his opinion. This debate highlights the experimental nature of using negative rates as a policy.” For more information, read our latest forex news.