The Bank of Japan (BoJ) has followed central banks in Denmark, the Eurozone, Sweden and Switzerland by imposing a negative interest rate on a portion of commercial bank reserves. In Switzerland and Sweden, the main policy interest rate, as well as the marginal rate on reserves, is below zero. Short-term interbank interest rates are negative in all five cases – see charts.

Danish rates were cut below zero to preserve the currency peg with the euro. Unwanted currency strength was also a key reason for the Swiss and Swedish moves to negative. The ECB and BoJ justify negative rates by reference to their inflation targets but both central banks have welcomed currency weakness in recent years.

An individual bank can avoid negative rates by using excess liquidity to increase lending or invest in securities. This is not, however, possible for the banking system as a whole, since the total amount of reserves is fixed by the central bank. A reduction in reserves by one bank will be matched by an increase for others. Negative rates, therefore, act as a tax on the banking system. The Danish, Swiss and Japanese systems reduce this tax by imposing negative rates only on the top tier of bank reserves.

Supporters of negative rates argue that a cut to below zero provides a net economic stimulus, even if the effects are smaller than a reduction when rates are positive. The move to negative, they claim, puts further downward pressure on banks’ lending and deposit rates, boosting borrowing and deterring “hoarding”. It also encourages “portfolio rebalancing” into higher-risk / foreign investments, implying a rise in asset prices and / or a fall in the exchange rate. Higher asset prices may yield a positive “wealth effect” on demand, while a lower currency stimulates net exports.

Opponents of negative rates argue that they squeeze banks’ profitability, making them less likely to expand their balance sheets. Banks in the above countries have been unwilling to impose negative rates on retail deposits, fearing that such action would trigger large-scale cash withdrawals. This has limited their ability to lower lending rates without damaging margins. Banks need to maintain profits to generate capital to back lending expansion. Any boost to asset prices from negative rates, moreover, is likely to prove temporary without an improvement in “fundamentals”, while exchange rate depreciation is a zero-sum game.

Radical thinkers such as the Bank of England’s Andrew Haldane have suggested increasing the scope and effectiveness of negative rates by placing restrictions on or penalising the use of cash. Such measures could allow banks to impose negative rates on retail as well as wholesale deposits without suffering large-scale withdrawals, thereby increasing their ability to lower lending rates while maintaining or increasing margins. Such proposals may be of theoretical interest but are unlikely to be politically feasible. They are dangerous, since they risk undermining public confidence in money’s role as a store of value.

Central banks’ experimentation with negative rates is likely to extend. ECB President Draghi has given a strong indication of a further cut in the deposit rate in March, while the recent BoJ move is widely viewed as a first step. The ECB may copy other central banks by introducing a tiered system to mitigate the negative impact on bank profits and increase the scope for an even lower marginal rate. The necessity and wisdom of such initiatives are open to question. The risk is that central bankers are opening Pandora’s Box and that any short-term stimulus benefits will be outweighed by longer-term damage to the banking system and confidence in monetary stability.

The PBoC’s fourth-quarter monetary policy report, released over the weekend, provides further evidence that monetary conditions have loosened, supporting an optimistic view of near-term economic prospects.

Bears claim that foreign exchange intervention has squeezed banking system liquidity, threatening a credit crunch. A previous post argued that the PBoC has more than offset the intervention drain by cutting banks’ reserve requirements. The latest report confirms this: banks’ excess reserves (i.e. the surplus over requirements) rose from 1.9% of their deposit base at end-September to 2.1% at end-December – see first chart.


With their liquidity position remaining healthy, banks have passed cuts in official benchmark interest rates through to borrowers. The average rate on loans to non-financial enterprises fell by a further 37 basis points (bp) last quarter, to its lowest level in data in data extending back to 2009; the average mortgage rate declined by 32 bp, to its lowest since the first quarter of 2010 – first chart.

In other news, foreign reserves fell by a further $99.5 billion in January, following a $107.9 billion December decline. The monthly reserves change exhibits a positive correlation with the spread between the offshore (CNH) and onshore (CNY) renminbi exchange rates versus the US dollar. The spread narrowed sharply last week, suggesting a slowdown in the reserves outflow – second chart.


Economic news flow is currently light because of the Chinese New Year. Last week’s Markit / Caixin purchasing managers’ surveys were encouraging, with both manufacturing and services polls stronger in January – third chart.


The OECD’s Chinese leading indicator*, meanwhile, accelerated further in December, according to data released today – fourth chart.


*See previous post for details of this indicator.