Interest Rates Lower Bound Not Reached
Over the last several years, the Swiss National Bank (SNB) has driven interest rates to historic lows in order to combat stubbornly weak economic growth, but it insists that the floor has not been hit.
Despite the fact that Swiss interest rates are already tiptoeing into negative territory, SNB Chairman Thomas Jordan believes there is room to cut rates even more. (Source: “Lower bound for Swiss rates not reached yet: SNB’s Jordan,” Reuters, October 24, 2016.)
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“In Switzerland, the cost associated with the current negative interest rate is clearly lower than the cost of holding cash,” said Jordon. “Consequently, demand for cash has not yet risen substantially. So the effective lower bound for interest rates has not yet been reached, but we know that it exists.”
By Jordan’s account, negative interest rates have actually started to achieve the ends promised by central bankers, by encouraging more economic activity. He holds this position while acknowledging the long-term downside risks posed by letting rates go negative.
“Despite (the) monetary policy challenges and potential side-effects, in Switzerland the negative interest rate is currently indispensable, owing to the overvaluation of the Swiss franc and the globally low level of interest rates,” he said.
Jordan quickly tempered those remarks by admitting that even negative interest rates have an expiration date. The central banks of the world cannot expect markets to accept downward pressure on rates into perpetuity, particularly as net margins for banking activities vanish.
He made sure to add that, “Nonetheless, the challenges and side-effects show clearly that we must aim for a normalization of monetary policy over time,” so that critics could not say he was insensitive to the risks.
The SNB includes substantial exemptions to negative rates on banks’ deposits, thus leaving those banks flexible on how much of the negative rates they pass on to clients. But banks aren’t the only ones having trouble with negative rates. Pension funds are desperate for a yield in these markets.
“The longer the low interest rate environment persists, the greater the risk that distortions in the banking system will arise, hampering the transmission of the negative interest rate via the credit channel,” Jordan said. “The SNB takes these concerns very seriously.”
