• We are facing this situation because of the low interest rate environment that has persisted worldwide since the “Great Recession”
• Negative interest rates are as bad as they sound. Let’s say the interest rate is a negative one percent (-1%). I'm the bank and you give me $100. Then in one year, I give you back $99?!?
• The negative rates are primarily seen in borrowing and lending between governments and banks in Europe and Japan – consumers haven’t had much exposure to negative rates, yet.
Most of us recognize that we are in a “low interest rate environment” and have been since the Federal Reserve and Central Banks across the globe began lowering interest rates and taking steps to keep interest rates low in response to the Great Recession.
The practical impact to consumers of low interest rates has meant meager fractions of a percent of interest on our savings accounts, bank CDs and money market accounts and potentially no interest on our checking accounts.
The Great Recession had a global impact, so this low interest rate environment has generally persisted throughout much of the world for the last eight years.
Unfortunately, in many countries the economic expansion has been much slower and much less robust than anticipated and as a result, policy makers in many countries are continuing to look for ways to do three things:
1) Juice the engine of economic expansion
2) Strengthen currencies and
3) Fight deflation by inducing some inflation
All three objectives are generally accomplished by lowering interest rates. Generally, lower interest rates attract more borrowing for companies that would like to start or expand their businesses and when more companies borrow and expand – boom -- it creates jobs and economic expansion. That expansion should lead to rising prices and modest inflation and the low rates should strengthen the currency. The problem is that interest rates have been at or near zero for years and if governments now want to lower them further to pursue any of the objectives above, that means the rates have to be pushed negative.
In both Japan and Europe, some kind of negative interest rate environment similar to this is exactly what is happening. In many places the negatives rates only apply to banks and government borrowing and lending with each other, but it is happening. Because the rates are only ever so slightly negative right now, many banks are absorbing the losses associated with negative interest rates when dealing with retail customers and as a result, their profit margins are getting squeezed.
What happens if rates continue to go even further negative and the banks profit margins get squeezed too much? That remains to be seen because no one really knows for sure what the impact of significantly lower interest rates will be. Demand for the negative interest rate currency will likely rise and demand for hard assets like precious metals and real estate will also likely rise. But there will also be many unintended consequences and "shadow banking" type activities as consumers try and preserve the value of their money.
If you would like to discuss negative interest rates further or the impact on your portfolio, please feel free to schedule a free consultation.
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- This generic information is provided for educational purposes only and should not be construed as a recommendation for any individual to take a specific action.
- Please invest prudently and seek professional help from a financial advisor, investment manager, accountant, lawyer or other professional on matters that you are unsure of or that are unique to your personal circumstances.
- Financial Advisor and Investment Management Services provided by J. Bradford Investment Management, Nashua NH.