Negative interest rates

The current economic climate has led to falling interest rates around the world and even to negative interest rates in some countries, such as Ireland. 

Negative rates could effectively mean that savers have to pay rather than earn interest on their savings. Some countries have already started to use negative interest rates, including the European Central Bank and the central banks of Japan, Sweden, Switzerland and Denmark, meaning that retail banks have to pay to store excess cash at the central bank safely.

The rundown
  • Negative interest rates are sometimes used to boost the economy after a crash or recession
  • Negative interest rates mean low interest rates on savings
  • The effect that negative interest rates have on a country’s economy can vary

What are negative interest rates?

Negative interest rates mean that financial institutions may have to pay interest to borrowers instead of earning interest from them, but savers could also be affected. Unfortunately, negative interest rates aren’t a new phenomenon. 

Which countries have negative interest rates?

The base rate is currently -0.5% (August 2021) in Denmark [1]. At the peak of the pandemic, Ireland and all the 19 nations in the Eurozone, along with Sweden, Switzerland and Japan, all had interest rates below zero. The current European Central Bank (ECB) rate for a deposit facility is -0.5% (December 2021).

How do negative interest rates work?

When the national base rate drops to a negative figure, banks incur a charge for holding their cash in the central bank – the Central Bank of Ireland in Ireland – rather than earning interest. This means banks then decide whether or not to pass this cost on to their savers.

What is monetary policy?

Monetary policy is how central banks control interest rates. Central banks operate in almost every economy in the world, controlling the cash supply for their respective economies. The EU has an overarching central bank, which is called the European Central Bank. A central bank’s primary purpose is to control inflation rather than the economy as a whole. 

Keeping inflation at the optimum level of around 2% is a tricky balancing act. If everyone pumps their money into the economy and takes out loans and credit cards, inflation can rise too high, resulting in central banks increasing interest rates to control it. 

If they increase interest rates too much, however, and nobody wants to spend or borrow because they are so high, inflation drops too low. 

As a result, central banks might decide to drop their interest rates and encourage people to spend again – sometimes resulting in negative interest rates. 

The ECB sets three main interest rates:

  1. A refinancing rate, which allows banks to borrow weekly from the Eurosystem at a set rate
  2. A deposit facility rate, which is for overnight deposits within the Eurosystem and is less that the refinancing rate
  3. A marginal lending facility rate on overnight credit at a better rate than the refinancing rate

Which countries have negative interest rates?

Following the global financial crisis of 2008, interest rates were cut around the world. The European Central Bank (ECB), the US Federal Reserve, the Bank of England and the Bank of Japan cut interest rates to almost zero, and in June 2014, the ECB cut its rate to -0.10%. Switzerland, Sweden, Hungary and Japan have since followed suit. The ECB rate for deposit facilities is still negative, at -0.5%, but the refinancing and marginal lending rates currently sit at 0.00% and 0.25% respectively (December 2021).

In some European countries, such as Germany and The Netherlands, banks are passing on the ECB’s negative interest rates to their corporate and retail customers. 

Over the last few years, banks all over the world have started using negative interest rates, as seen below [2].

Negative interest ratesNegative interest ratesNegative interest rates

An example of a negative interest rate

While it’s commonly thought that negative interest rates are a relatively new concept, they’ve actually been around for quite some time. Negative interest rates were used as a tool to kickstart the economy immediately after World Wars I and II, the latter at a time when the causes of the Great Depression were still being explored. 

As you can see from the chart below, low and negative interest rates were used in both the UK and the US after World War II to pay off war debts. These interest rates, coupled with increased pressure to purchase government bonds, was used as a model for financial recovery.

Sub-zero ReturnsSub-zero ReturnsSub-zero Returns

At the end of World War II, Britain’s government debt was more than twice as high as the GDP, and the Americans’ was almost 120% of their GDP. Ten years later, the percentages were only about half as high.

How can interest rates turn negative?

Interest rates can turn negative in times of great economic recession. Central banks in economies across the globe can make this decision to encourage populations to spend money and stimulate the market.

Why are negative interest rates being used?

Negative interest rates are an unconventional way of trying to stimulate economic growth by making it cheaper to borrow and therefore boosting spending and investment. If successful, negative rates could help prevent a global recession while easing the burden of debt that many economies are under.

What are the effects of negative rates?

Negative interest rates affect the economy, and within that, consumers, borrowers and lenders, in various ways.

Negative interest rates can affect the economy in the following ways:

  • Low-interest traditional savings accounts mean that savers might instead invest in the stock market to try and get a better return on their deposit, pushing stock markets up.
  • In turn, this can then lead to a stock market crash.
  • If there’s a recession, central banks don’t have many options left to try and stimulate the economy as there’s little scope to reduce rates further.

What are the effects of negative rates on consumers?

In theory, negative interest rates mean that consumers – both individuals and businesses – won’t earn as much interest on their savings as they once would, or the value of your savings will decrease. However, some banks have helped to ease this burden. In countries with negative interest rates, although banks may pass their costs on to savers who hold deposits with them, to date, few banks have done so.

How do negative interest rates affect borrowers?

In simple terms, negative interest rates mean borrowers benefit, while savers don’t. This is because borrowers effectively pay less back than they originally borrowed, while savers might have to pay their bank to keep their money for them. 

In some countries, such as Denmark, banks actually offer negative interest rate mortgages, where the investors take the hit rather than the banks themselves.

How do negative interest rates affect lenders?

There’s a common argument as to how negative interest rates affect lenders specifically. During times of high interest rates, cash flow usually increases, as shown in the chart below. This is because consumers take advantage of better returns, knowing they’ll earn more interest. Therefore, a counter argument against using negative interest rates to boost the economy is that they could have the opposite effect.

Cash in CirculationCash in CirculationCash in Circulation

Do negative interest rates work?

After World War II and the 2008 financial crisis, negative interest rates proved to be a valuable tool – when used sparingly. In the wake of the coronavirus pandemic, some countries, such as the United States, opted to steer clear of adopting such methods due to the mixed evidence on whether they really work. 

Who benefits from negative interest rates?

Negative interest rates are arguably seen as a tool against unprecedented economic turmoil, used to boost the economy and create a surge of borrowing by facilitating low rates on lending. The theoretical aim of negative interest rates is to benefit everyone by improving the economy.

What does negative interest rates mean for borrowers?

In theory, negative interest rates mean that savers won’t earn as much interest on their deposits as they once would, but some banks have helped to ease this burden. In countries with negative interest rates, although banks may pass their costs on to savers who hold deposits with them, to date, few banks have done so.

What might this mean for your savings?

Although the base interest rate in Ireland is not currently negative, it has been on a downward trend over the last few years and is currently 0%. Interest rates on certain savings accounts are low, so you may be wondering where to look for competitive interest rates.

You can guarantee a risk-free return on your deposit by opening savings accounts with a fixed interest rate, such as term deposit accounts. If you have a lump sum you’d like to invest and can afford to lock your money in for a set time, you’re more likely to earn a competitive interest rate. 

At Raisin, we have partnered with banks offering deposit-protected savings accounts that beat interest rates’ downward trend.

Avoid negative interest rates with a savings account at Raisin Bank

To open savings accounts from our partner banks, you first need to open a Raisin Account; then you can apply in just three steps:

  1. Log in to your Raisin Account
  2. Click to apply for a savings account 
  3. Transfer your deposit 

Once your application is approved, simply deposit your savings and start earning money straight away. 

If you’ve got any questions, please contact our Customer Services Team, who will be happy to help.

Sources:

1. https://www.nationalbanken.dk/en/marketinfo/official_interestrates/Pages/Default.aspx

2. Reproduced from https://itfa.org/the-upside-down-world-of-negative-interest-rates-by-giovanni-bartolotta-cro-at-aps-bank-plc-jan-2020/

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