What are negative interest rates?

Generally speaking, high interest rate are welcome for savers and less good welcome news for borrowers – when banks raise interest rates, you can expect to earn more interest on the money you have put away in savings, and also pay more on any money you’ve borrowed, in the form of a home loan or other kind of loan.

Interest rates typically tend to be positive integers – the lowest they have been in recent times on our shores was in the early days of the COVID pandemic. In an attempt to mitigate the ongoing economic effects of the pandemic, the Reserve Bank of Australia (RBA) cut the cash rate to 0.01%, and banks and lenders followed suit, offering low rates to borrowers.

So what if interest rates were ever to fall below zero? How could that happen, and would bans flip the script, paying you interest to borrow money from them and charging you on the money you have in savings? While rare in Australia, some countries have actually experienced negative interest rates – here are some important things to know about how they work.

What are negative interest rates?

Negative interest rates happen when the rates that financial institutions apply to consumers or investors borrowing money or putting into savings fall below zero. Interest rates are usually positive, meaning people earn interest on their savings and have to pay it when they borrow. But with negative interest rates, the opposite can happen.

Given how used we’ve become to how interest usually works here, negative rates would seem like the financial equivalent of water flowing up a hill, the sun rising at nighttime or a white Christmas in Darwin.

In general, it’s very rare for banks to apply negative interest rates to consumer products like savings accounts or home loans. Indeed, the Canstar database, which stretches back more than two decades, has never seen negative rates on these products.

But it’s not unheard of for governments to borrow and lend at negative rates or for national central banks, like the Reserve Bank of Australia (RBA), to set a negative cash rate. This would mean that the central bank would likely charge retail banks (the ones consumers use) to keep money on deposit with them.

One of the reasons a central bank might lower rates is to encourage retail banks to lend money to consumers and businesses, instead of leaving that money on deposit and being charged interest.

In turn, retail banks are expected to pass on the interest rate decreases to their customers, encouraging them to borrow and discouraging them from keeping their money in savings accounts or term deposits.

That’s the theory anyway, but what’s the ultimate aim of all this? As the RBA puts it, “a reduction in the cash rate typically stimulates spending and inflation”, so would negative interest rates simply be an extreme form of economic stimulus?

What causes negative interest rates?

Negative interest rates are traditionally introduced to try and help revive a slow economy. If a country’s economy is experiencing low or negative growth, unemployment is too high, wages aren’t going up, people aren’t spending money and prices aren’t increasing (or in other words, if inflation is too low), a central bank may take steps to bring down interest rates. The idea would be to give the economy a jump-start by encouraging consumers to borrow and spend more.

When the RBA made its historic cash rate in November of 2020, the RBA’s board mentioned contributing factors such as the high level of unemployment and the hope that, with the aid of economic stimulus, the economy would eventually return to pre-pandemic levels of output.

Could Australia experience negative interest rates in the future?

Even after its series of cash rate cuts in 2020, which ended with the official cash rate at its lowest ever level, the RBA said it’s would be “extremely unlikely” that it would employ a policy of negative interest rates, because it believed that any benefits would be “”outweighed by the costs”.

COVID was one of the most extreme disruptions to the Australian economy in recent decades,  so therefore, barring another crisis of this magnitude, it’s unlikely that we will face the prospect of negative interest rates at any point soon.

Who are the main winners and losers when interest rates head towards negative?

Potential winners:

• Borrowers: Lower interest rates typically mean less interest to pay back on money borrowed from banks. Indeed, negative interest rates would mean a bank ends up effectively paying you to borrow money from it.

• Visitors to Australia: The RBA explains that, generally speaking, when a country lowers interest rates, its currency tends to weaken. If Australia’s interest rates continue to slide, buying and using Aussie dollars could, in theory, become cheaper for foreign tourists, as soon as they are allowed to travel here again.

• Exporters: Australian companies selling goods overseas could also benefit from a weakened Aussie dollar, because it would make Australian goods cheaper to foreign buyers. This could lead to an increase in Australian exports.

Potential losers:

• Savers: A negative interest rate could mean losing money if you have funds in a savings account or term deposit with a bank.

• Australians spending money overseas: If interest rates continue to drop and the Aussie dollar becomes weaker as a result, buying a foreign currency or transferring cash to another country could become more expensive based on exchange rates.

• Pensioners: Pensioners, particularly those who rely on income from savings accounts or term deposits, and potentially also those whose pension eligibility is assessed using deeming rates, may be potentially worse off.

• Importers: A weak Aussie dollar, a potential side effect of lower interest rates, could make it more expensive for businesses here to buy goods from overseas. However, according to the RBA, it can take a long time for that to have an impact on the prices consumers pay for imported goods at the checkout.

Have other countries had negative interest rates?

There is some historical precedent for negative interest rates. They have been seen in Europe, notably in Sweden, where the central bank cut its overnight deposit rate for banks to -0.25% in July of 2009. The aim of this move was to raise domestic inflation, but according to the Cato Institute, it also had the effect of driving real estate prices up sharply, and ultimately contributing to wealth inequality in the country.

As the European economy attempted to steer through the effects of the COVID pandemic, Switzerland and Denmark had negative interest rates in 2021, while a further 22 European countries also had an official cash rate of zero. In Asia, Japan also had an interest rate of -0.10% at the beginning of 2021.

In 2019, Danish lender Jyske Bank made headlines by offering what was reported to be the world’s first negative interest rate home loan, with some borrowers able to take out a 10-year mortgage at -0.5%. This year, another lender, Nordea Bank Abp, began offering Danes 20-year mortgages at a fixed rate of 0%.

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Original article by Sean Callery. Main image source: Ground Picture/Shutterstock.com