Negative interest rates: What you need to know

(Newshub.)
(Newshub.)

The world's central bankers are increasingly venturing into unknown territory, adopting what are known as negative interest rates.

Japan recently followed the Eurozone nations, Switzerland, Denmark and Sweden and cut some rates to below zero.

Whether we like it or not the decisions made by the central bankers in those countries will have an impact in New Zealand.

When people talk about negative rates they are not talking about negative mortgage rates.

Instead they are talking about money deposited by the trading banks with the central bank.

Traditionally the commercial banks earn interest on their money when they park it with the central bank. But when rates turn negative it means they have to pay the central bank to look after their surplus funds.

This is an added cost for the banks. So the theory goes that rather than paying to park their money the trading banks will lend that money to businesses and to individuals. The hope is that this will encourage economic growth.

The central bankers are also hoping that the commercial banks will cut their customers' deposit rates, encouraging savers to go out and spend and invest.

When people in countries like Japan earn less money on their savings they naturally start looking for somewhere that is offering better returns.

New Zealand is one of those places. So is Australia.

The higher returns on offer in New Zealand (from bonds and dividends) encourage people to invest here. It is one of the factors that has driven up our dollar for years. Long before rates went negative investors in countries like Japan were putting their money into New Zealand. It is what currency dealers call the "carry trade".

The more money that is poured into New Zealand the more the dollar stays strong.

A higher dollar is not something exporters want to see. Nor will it please New Zealand's Reserve Bank.

A rising New Zealand dollar could put more pressure on the Reserve Bank to cut the official cash rate (OCR) from 2.5 percent.

The OCR is the interest rate the Reserve Bank charges when it lends money overnight to the commercial banks. It has an influence on all the other rates set by the banks (mortgage rates, personal loan rates, credit card rates and savings rates.)

So a lower OCR is one way that the Reserve Bank can try to lower the dollar. If the OCR falls then deposit rates will fall as well. In theory that makes the deposit rates on offer here less attractive to offshore investors.

Economists already expect the RBNZ to cut the OCR by 0.25 percent this year. Some predict the OCR will be 2 percent by the end of the year.

Australia's Reserve Bank faces the same predicament. Its key rate is two percent.

Two percent sounds high to an investor in a country where rates are at zero percent, or lower.

It is not clear whether negative rates work.

Analysts at Morgan Stanley have called it a "dangerous experiment". They are concerned that it can hurt bank profits, adding to the risks to the global economy.

There have certainly been some unexpected consequences.

In some cases it has encouraged people to save even more, rather than spending or investing their money.

Why? The prospect of negative rates has spooked them. They feel even less certain about their retirement, so they want to hold onto their money.

Despite the uncertainty you can expect to hear a lot more about negative rates.

The experiment is far from finished.

Newshub.

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