Negative Interest Rates Explained

Explaining all about negative interest rates, why they exist and what they mean for the economy and home loans

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, updated on August 7th, 2023       

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How can an interest rate possibly be negative, you may ask?  Does this mean you have to pay a bank to deposit your savings?  Many countries in the western world now have an official negative interest rate, so read on with Savvy to find out how negative interest rates work and what they might mean for you and your savings.

What is a negative interest rate?

A negative interest rate is one which is set below 0% by a country’s central or state-controlled bank during a period of deep economic recession.  It is a form of economic policy which is designed to encourage spending and lending rather than storing or saving money.  It is an economic stimulus measure designed to stop deflation and encourage investment.

During the worst of the COVID-19 pandemic, many nations turned to negative interest rates to stimulate their economies, including the European Union, Japan, Switzerland, Sweden and Denmark.

Why would a country’s central bank declare a negative interest rate?

Central reserve banks declare a negative interest rate to discourage commercial and retail banks from hoarding cash reserves.  If these banks have to pay to store their money, which is the effect of a negative interest rate, they’re more likely to lend the money out to borrowers rather than keep it and lose money.  This acts as a stimulus to a country’s economy and encourages companies to invest in growth, which in turn counters deflation and encourages inflation.  If money is cheap to borrow, more companies can afford to borrow money to fund their expansion, which in turn creates jobs and reduces unemployment.

Who benefits from very low or negative interest rates?

A negative interest rate benefits borrowers who are looking for a home loan, because it means that retail banks can lend money more cheaply.  The effects of very low interest rates are felt by retail customers as the intensity of competition between home loan lenders heats up, resulting in lenders offering highly competitive home loans with very low interest rates starting with the number one.  In addition, there are now no-fee mortgages, loans with no account-keeping fees, cashback offers to encourage borrowers to refinance, and many other financial incentives to gain new customers.

If Australia’s interest rate did go negative, what would the effect on Aussie home loans be?

This is difficult to predict, as Australia has never experienced a negative interest rate (although the current rate of 0.1% is almost as close to zero as possible).  The only experience to draw on would come from Denmark, where that country’s third largest bank, Juske Bank, began offering a 10-year fixed interest loan at -0.5% in 2019.  Questioned about how this would work, the bank said borrowers would still have to make a monthly repayment as usual, but the amount they owed would be reduced each month by slightly more than the borrower’s repayment amount. However, if fees and charges are added back in to the cost, the borrower will still end up paying the bank to borrow its money.

Is Australia’s interest rate going to go negative?

Probably not – Reserve Bank of Australia (RBA) Governor Phillip Lowe considered a negative interest rate for Australia in 2019, but discounted the idea.  In a speech to the Australian Parliament in August 2019, Dr Lowe said: “I acknowledge that lower interest rates do hurt the finances of the many Australians who rely on interest payments…”  Australia’s interest rate has been below one since October 2019, but as inflation increases during 2021 and 2022 the prospect of the RBA increasing interest rates becomes more likely into 2022 and 2023.  As of February 2022, the RBA chose to leave Australia’s official cash interest rate at 0.1%.

What are other effects of a very low interest rate?

A low or almost zero interest rate also benefits visitors to a country, because a low interest rate usually results in a weak currency, which means tourists visiting Australia will get more Australian dollars in exchange for their own currency. This could mean a boost for tourism, because as international borders are reopened, more visitors may choose to holiday in Australia due to a lower exchange rate.

Exporters can also benefit from a lower Australian dollar, as it means that Aussie goods seem cheaper to foreign buyers, which in turn could lead to an increase in exports from Australia to the rest of the world.

Low interest rates – also a boost for the unemployed

As companies and manufacturers expand their production with the help of cheap loan money, they create more jobs, which in turn results in a reduction in unemployment.  This benefits the unemployed, who in turn spend their increased income on goods and services, which further stimulates the economy and leads to increased inflation, and eventually increased wages.

More explanations about negative interest rates

Is inflation always a bad thing?

No – inflation isn’t always a bad thing, as it can indicate that a country’s economy is recovering from a period of depression or deflation.  However, if inflation occurs too quickly, it can also lead to serious economic issues.  For instance, in Argentina during the 1980s, inflation reached an estimated 4,923% before the government created a new monetary system in 1990 which eventually stemmed the runaway inflation rate.

Does a negative interest rate always lead to a lower exchange rate?

Yes – a negative or very low interest rate (below 1%) means that foreign investors in that country will earn less money for their investments.  This will lead to a lower demand for that country’s domestic currency, which will then reduce the exchange rate paid for the currency compared to the American dollar.  A lower exchange rate also leads investors to find alternative ways to store and grow their wealth, such as investing in stocks and shares, gold or property rather than having cash deposits generating no interest.

Who are the losers from a very low or negative interest rate?  

Aussies heading off overseas will notice they get less spending money on their holiday if low interest rates push the Australian dollar lower. Also, importers who rely on buying components or parts for their manufacturing process overseas will also be affected by a low dollar value, which will in turn cause them to increase the price of the goods they sell to consumers, and so stimulates inflation.

What are the implications for savings accounts when a negative interest rate occurs?

Savers and those who rely on interest earnings are the biggest losers when interest rates are very low.  This can affect aged pensioners who may have planned to live off the interest earned by their savings in their retirement years.  However, in reality, a negative interest rate only affects commercial banks in their dealings with each other and with the country’s central reserve bank, as banks do not directly pass on negative interest rates to their retail customers.  The implications of almost zero interest rates on savings accounts are that those with cash savings do not gain interest on their deposits, and so they look elsewhere for ways to grow their wealth.

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