24 October 2018
Japan has adopted negative interest rates, but that didn't stop its currency from gaining in strength recently. Photo: Bloomberg
Japan has adopted negative interest rates, but that didn't stop its currency from gaining in strength recently. Photo: Bloomberg

Negative interest rate may not always do the trick

Eurozone, Denmark, Switzerland, Sweden and Japan have all introduced negative interest rates over the last 18 months. However, those central banks didn’t take the action during the economic trough.

For example, the ECB didn’t cut rates to negative territory until June 2014, even though the region grappled with recession for two straight years after the 2012 debt crisis.

When it did finally push the rates negative, the central bank said that it has made the move in order to achieve the medium-term inflation target amid deflationary risk.

Denmark, Sweden and Switzerland all have kept their own currencies. As small-size economies, these nations have close economic links with the eurozone. Hence, massive capital has flowed into these nations during the eurozone debt crisis, which has driven up local exchange rates.

Denmark has pegged the Danish Krone at 7.46038 against the euro, and the unit could float in the range of 2.25 percent. When ECB cuts or raises interest rates, Denmark would usually follow suit.

The country was forced to impose negative interest rate in July 2012 in light of huge capital inflow after the euro-area debt crisis. That has affected its currency, economy and asset prices. And the nation kept negative interest rates until April 2014.

Switzerland also once pegged its franc at 1.2 against the euro during the debt crisis to prevent excessive capital inflow. It abandoned the peg after the debt crisis.

As for Sweden, it never adopted any currency peg during the debt crisis.

Denmark, due to its currency peg, had to cut rates after the ECB introduced negative interest rate in June 2014. And Sweden and Switzerland reduced interest rates to negative levels in December 2014 and February 2015 respectively.

The moves were prompted by the desire to curb capital inflow and ease pressure on currency appreciation, rather than to stimulate their economies.

By contrast, Japan has maintained very loose monetary policy for long time. Prime Minister Shinzō Abe vowed to revive the nation’s economic growth mainly through extra-loose monetary policy.

The Bank of Japan not only expanded the monetary easing measures, but also tried to weaken the yen through money supply to boost the nation’s competitiveness.

The Japanese currency’s value was down nearly 50 percent at one point, compared to earlier levels.

However, the unit has gained strength recently as global investors sought safe-haven assets amid heightened worries in international financial markets.

The Bank of Japan announced negative interest rates in January this year in order to further weaken its currency.

In theory, negative rate has the same effect as that achieved through normal interest rate cuts. However, the execution of negative interest rate has many limitations. It would affect banks earnings, as banks may not necessarily pass on the negative rate to customers.

It would encourage high-risk investment. Also, the lending rate may not drop to negative level.

Let’s now look at how the negative interest rate worked in different nations.

The eurozone has turned out to be the biggest beneficiary. The region’s real effective exchange rate has declined by 8.2 percent. The ECB has adopted monetary easing and introduced two rate cuts, as well as maintained market expectation for further easing measures.

In addition, the market has since mid-2014 been focused on a Fed liftoff, helping provide upward momentum for the US dollar. It also helped ease the euro.

By contrast, negative interest rate has not worked well in Japan. The yen posted a sharp rebound and soared to 112 against the dollar from a bottom at 121 as investors were worried about global economic growth prospects and financial market turmoil.

The Japanese currency has gained 7 percent against the dollar within one month. Thus, we can see that negative interest rates may not always do the trick in guiding exchange rates lower.

Ricky Choi Wing-Hung, a senior economist at Bank of China (Hong Kong), contributed to this article which appeared in the Hong Kong Economic Journal on March 9.

Translation by Julie Zhu

[Chinese version 中文版]

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General manager, development planning department, BOC (Hong Kong)

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