Speeding to NIRP Factor -1

Central Banks across the globe are rushing headlong into unknown territory called Negative Interest Rate Policy (or “NIRP”).  The economic argument for taking benchmark rates negative is to stimulate inflation and to attempt to stop the global economy slipping into a deflationary spiral.

On the 11 February Sweden’s Riksbank cut its repo rate to minus 0.5% per annum with the consensus view that it was trying to front-run further easing by the European Central Bank and therefore to weaken the Swedish Krona (to stimulate inflation).

fig 1

The Bank of Japan have imposed negative rates on banks in Japan depositing cash with it – again in an effort to stimulate growth and inflation and to penalise the banks for holding cash reserves.

During her recent semi-annual testimony to Congress, Janet Yellen, the Chair of the US Federal Reserve (the US Central Bank), stated “In light of the experience of European countries and others that have gone to negative rates, we’re taking a look at them again.”

The strategy is clearly having a negative effect (no pun intended!) on the value of financial institutions, as evidenced by the falls in share prices for a number of major European Banks and the cost of insuring against a default by those banks.  The latter is characterised by contracts known as Credit Default Swaps and these are instruments that reflect the cost of insuring against a specific financial institution defaulting on any of its bond obligations.  As you can see from the chart below, the cost of buying such insurance for a range of major European Banks has risen significantly in recent weeks.

fig 2

The NIRP strategy means we have a negative feedback loop:

  • As benchmark rates fall, so banks will reduce the rate of interest that they will pay on cash deposits from investors;
  • The deeper rates move into negative territory, the lower the profits will be for financial institutions, and this will put pressure on their earnings. This could feed through into credit rating downgrades;
  • If NIRP still proves to be ineffectual at stimulating inflation (and there is no empirical evidence to suggest that it will spur higher inflation) then the Central Banks will be forced into even more aggressive Quantitative Easing and a probable further reduction in longer term interest rates.

From a practical perspective, clients will need to:

  • Monitor closely counterparty credit ratings within treasury management policies to ensure that they are not breaching current criteria; and
  • For those who have stand-alone swap transactions, the mark-to-market could increase even further and might trigger additional collateral calls from the counterparties.

For further information please contact either Richard Murphy, Christopher Jack or David Mairs from Murja on 020 3195 2800 / 2801 or visit their website. Murja is a member of General Industries PLC group, which also includes Altair.

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