For a world first, the announcement came with remarkably little fanfare.
But last month, the Swedish Riksbank entered uncharted territory when it became the world’s first central bank to introduce negative interest rates on bank deposits.(…)
Mervyn King, the Bank of England governor, has hinted he may follow the Swedish example as the danger of a so-called liquidity trap, where cash remains stuck in the banking system and does not filter out to the wider economy, is an increasing concern for the UK.
Hoarding is exactly what happened in Japan earlier this decade when the Bank of Japan implemented quantitative easing between 2001 and 2006. Japanese banks refused to lend, in spite of central bank stimulus, because of fears over the dire state of the economy.
If this continues to happen in other economies, central bankers may be left with little choice but to follow the Swedish example. John Wraith, head of sterling rates product development at RBC Capital Markets, says: “The success of the UK’s quantitative easing experiment hinges a lot on whether the banks will use the extra money they are getting for lending to individuals and businesses.
“If there is no sign of this over the next few months, then the Bank of England might consider a negative interest rate. In essence, it is a fine on banks that refuse to lend.”(…)
In Europe, the European Central Bank is considered less likely to introduce negative interest rates.
This is because it has maintained higher official rates than other banks and used money market operations to act as a stimulant instead. For example, it offered commercial banks unlimited funds for one year at the end of June.
But it does have the same problem as the Bank of England in assessing the success of its policy. Like the UK, commercial bank deposits at the ECB have shot up in the past few months.
At this stage, the US also seems unlikely to introduce the policy as there has been little debate on the matter and no hints from policymakers about it being an option.
At the Riksbank, which now has a deposit rate of minus 0.25 per cent, the most vocal advocate of the policy is deputy governor Lars Svensson, a world-renowned expert on monetary policy theory and a close associate of Ben Bernanke, chairman of the US Federal Reserve, since they worked together at Princeton University.(…)
Carl Milton, fixed income analyst at Danske Bank in Stockholm, cautions that the Riksbank decision was not as pioneering as some have portrayed. The Bank routinely keeps its deposit rate 50 basis points lower than the repo rate to regulate liquidity in the market, he says. When the repo rate was cut to 0.25 per cent, the deposit rate was automatically forced into negative territory. “It was not something put in place to punish banks or to force them to lend,” he says.
Moreover, Swedish banks make relatively little use of the central bank deposit facility, limiting the impact of negative rates.
But by breaking the taboo surrounding sub-zero rates, the Riksbank may have set an important precedent that others could use to greater effect. Don Smith, economist at Icap, says: “Sweden’s policy is certainly very interesting. We will have to wait and see what happens there. This is certainly a very unusual policy, but these are very unusual times.”
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