Feb 02, 2016

What Do Negative Interest Rates Mean?

The Bank of Japan surprised markets when they moved to a negative interest rate. In our latest blog, we discuss what negative interest rates mean, and how this impacts our portfolio.

Last week, the Bank of Japan (BOJ) surprised markets when they moved to an interest rate of minus 0.1% for certain reserves deposited by commercial banks. One problem that has been common to Japan and other developed countries is excess cash in the banking system. Many corporations have been stockpiling cash and depositing it with their commercial banks and short term money market instruments. Commercial banks, in turn, have also been accumulating cash which is deposited with their central bank. The BOJ implemented negative interest rates to encourage the banks to get this cash working for the Japanese economy.

Since 2014, Sweden and Switzerland have implemented negative interest rates with the goal of spurring their respective economies. Already having used cheap lending rates to encourage borrowing for years, these central banks were looking for new ways to spur growth. The solution was to unlock the excess cash tucked away in the central bank reserve. When the BOJ set its rate on a portion of reserves in negative territory, it created a deterrent to accumulating cash. The commercial banks not only lost a source of interest income on their reserves, they were now being charged on their reserves. To limit the cost of maintaining reserves and make up for the lost revenue, the commercial banks would have to reduce the level of excess reserves and use the proceeds to write more loans for business, investment or real estate lending, with the end goal being to stimulate the economy.

Negative interest rates are a new tool in combating a sluggish economy and the Bank of Canada has raised the possibility of seeing negative interest rates. It seems that this monetary strategy is currently on the backburner as the recently released economic indicators point towards a recovery in the non-resource sectors. In addition, the current willingness by the Canadian federal government to enact a fiscal stimulus package would put negative interest rates further down the line of policy tools.

At CWB McLean & Partners, we have Japanese exposure through our International Equities Strategy. Two Japanese companies that we own are Nissan and Sony. As interest rates remain lower for longer, we expect our Japanese equities to provide long-term capital appreciation.