Negative Interest Rates on the Horizon

(May 3, 2013) — Investors in the Eurozone should be readying themselves for negative interest rates following the announcement by the region’s central bank that they are open-minded about such a move.

European Central Bank (ECB) President Mario Draghi yesterday said his committee had discussed the possibility of bringing the deposit rate – which has been at 0% for nearly a year – into negative territory. He added that the institution was prepared to deal with any consequences the move may bring. He also announced a cut in the refinancing rate from 0.75% to 0.5%.

Even before considering any effect the move would have on liabilities, reducing deposit rates would essentially mean investors would have to pay banks and other financial institutions to hold their cash and incur huge supplemental costs.

Some countries outside the Eurozone have already moved in this direction, which has forced reaction in the financial services sector.

Last year custodians BNY Mellon, RBC, and State Street imposed charges on investors holding deposits in Danish krone. RBC and State Street also told clients holding Swiss Francs that they would be liable for an extra fee due to negative short-term market rates.

Rates were reduced by these countries in an attempt to weaken currencies and protect domestic companies and exporters.

Alongside more charges, the hunt for yield that has plagued investors for the past few years would be further intensified. Rates were reduced to 0% in July, and this, in TwentyFour Asset Management Managing Partner Mark Holman’s view, was an important factor in kick-starting markets.

“The result was a flight to high-quality low-volatility assets, such as highly-rated asset backed securities and shorter-dated government bonds,” Holman said. “It was this move that really started the rally of 2012 by creating the strong technical position in the market, and then when he followed it up with his famous speech later that month the scene was set for the rally that markets have now enjoyed for nine months. A move to negative rates means that the race to zero yields is really on. For fixed income markets this would be the most positive scenario that we can envisage, certainly in the short term at least.”

Markets widely expected Draghi to lower the refinancing rate, but were not expecting such a candid nod towards cutting rates further.

Franz Wenze, Axa Investment Management’s head of investment strategy, said the move was encouraging for the European economy overall

“According to President Draghi, the negative side effects could be managed,” he said. “This is, in our view, a fairly bold statement and clearly means that the ECB is ready to go the ‘extra mile’ should the economic environment worsen further. This is also a logical consequence of what is known as the ‘whatever it takes’ approach to help the euro.”

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