What is a negative interest rate, and what would it mean for you?

Monday, 18 May 2020

The Reserve Bank is taking further steps to cushion the economic impact of the coronavirus pandemic.

You might have heard discussion in recent weeks of the possibility of New Zealand's official cash rate falling below zero.

It’s currently 0.25 per cent, a record low, but some commentators have predicted it could turn negative as the country responds to the Covid-19 economic crisis. Westpac is expecting we could have a negative official cash rate by the end of the year.

But what would that actually mean?

* Kiwibank, ASB drop home loan interest rates below 3 per cent for the first time

* 'This is not just a flu': ANZ tips OCR cut to combat coronavirus economic slowdown

What is a negative interest rate, anyway?

A “negative” interest rate turns the financial world on its head. Instead of being paid to save and charged to borrow, as we're used to, there's a bill for saving.

It's important to note the discussion in New Zealand has largely been about a negative official cash rate – the wholesale rate banks pay — not the retail rates offered to customers.

A negative official cash rate would mean the banks would be charged for holding their money with the Reserve Bank overnight, rather than lending it out.

Reserve Bank Governor Adrian Orr hasn't discounted the possibility of negative interest rates.

It is intended to have the effect of increasing banks’ desire to lend.

ANZ chief economist Sharon Zollner describes it as turning “money into a hot potato”. Even if banks could only lend to people at very low interest rates, “they’re not having to pay them to take the money”.

While Zollner isn’t picking a negative rate yet, she said she was not ruling it out, either.

If New Zealand went negative, it wouldn’t be the first country to do so – the European and Japanese central banks slipped into the red years ago.

Would we be charged to have a savings account?

Internationally, it's unusual for a negative cash rate to turn into a negative retail rate, although some European banks have charged people to have large sums of money on deposit.

Putting aside the fact we're already paying fees for savings accounts, a negative cash rate is unlikely to mean a penalty for having your money in a bank savings account.

Zollner said banks relied on deposits from investors for funding. If they started to charge depositors to hold their money, that stream of funding could dry up.

Economist Gareth Kiernan, of Infometrics, agreed: 'It’s a reasonably secure source of funding given the uncertainty there is on international financial markets.'

And would we be paid to have a loan?

Unless you can stomach charging savers, you generally can't bring in a negative interest rate for borrowers, either.

Sharon Zollner said a negative official cash rate would turn money into a 'hot potato'.

What borrowers are charged is higher than what savers are paid. (Across all the banks, there was a margin of 2.1 per cent difference at the end of 2019.)

Kiernan said an official cash rate of -0.5 per cent could drop the floating mortgage rate to 3.75 per cent, from about 4.45 per cent at present.

He said fixed rates could fall below 2 per cent.

'Swap rates are already pricing in some smallish possibility of an official cash rate cut from here, but seem reluctant to go too low for now because the Reserve Bank has said it’s not going to happen this year and they have other tools at their disposal.

'If a cut did eventuate, then it would also pull these rates lower, most particularly at the shorter end, and could knock another 50 basis points off one- to two-year fixed mortgage rates. Those rates are already under downward pressure given as bank funding costs have eased over the last few weeks.'

Would it mean banks ended up offering a lot more loans?

Maybe, but maybe not.

Zollner pointed out that even if banks had to pay to have their money with the Reserve Bank, that was a risk-free proposition for them.

Lending it out was not – particularly if the economy was suffering. “If they think the world is a very risky place, the risk-adjusted return from the Reserve Bank doesn’t look that bad. It depends on what else is going on.”

Zollner said there could be negative consequences if a low interest rate environment continued for a long time, even if it never actually went negative.

Very low interest rates, and negative rates, were “doing everything they can to persuade people not to save for the future” and a consequence of that was that there was more financial stability risk, she said.

Banks’ systems are also not set up to handle a negative interest rate environment at present and that would require significant work before the change could happen.