Arab Today, arab today what are negative interest rates and how do they work
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Arab Today, arab today
Arab Today, arab today

What are negative interest rates and how do they work

Arab Today, arab today

Arab Today, arab today What are negative interest rates and how do they work

The ECB cut Thursday its key deposit rate to minus 0.4%
Frankfurt - AFP

Desperate to jolt the eurozone economy back to life, the European Central Bank has cut a key interest rate that was already at less than zero.

But what does this negative interest rate mean, how does it affect the economy and is it good or bad news for consumers?

The ECB cut Thursday its key deposit rate to minus 0.4 percent from minus 0.30 percent previously.

The ECB has three main interest rates with which it can steer prices and, by extension, the economy.

And the bottom rate, the deposit rate, is the interest the central bank normally pays to commercial banks when they choose to keep excess funds left over at the end of the day at the ECB.

However, as it repeatedly lowered rates to ever-new historic lows to stimulate the economy, the ECB eventually brought down its deposit rate to below zero for the first time in June 2014, effectively charging banks for using its deposit facility.

And it cut it again in September 2014, in December 2015 and in March 2016.

- Impact on the economy -

In the wake of the eurozone's financial and debt crisis, banks became wary of lending money to households and businesses for fear of a possible default.

They preferred to hoard their excess cash at the ECB instead, because there, at least, they could receive interest on it.

However, the complete collapse in lending in the single currency area emerged as a major obstacle -- and even threat -- to the region's economic recovery, because credit is a vital lubricant that keeps the economy running smoothly.

Hence, in a bid to dissuade banks from hoarding liquidity and kick-start lending to the real economy instead, the ECB cut its deposit rate below zero.

That meant banks were effectively charged -- or "penalised" -- for letting their cash sit idly at the ECB instead of pumping it into the economy.

Other central banks -- in Switzerland, Sweden and Japan -- have also introduced negative interest rates.

- What they mean for banks -

Even before the deposit rate turned negative, eurozone banks were complaining that the low-interest rate environment was making it increasingly difficult to find and offer attractive returns to investors.

But after the ECB pushed the deposit rate into negative territory in June 2014, banks argued that having to pay the central bank to hold their excess liquidity was actually eating away at their profits.

Banks with a larger retail business, in particular, tended to feel the pinch more as they have so far refrained from passing on the negative rates to their clients.

- Impact for consumers -

For borrowers, low or negative central bank rates are a boon. The ECB's other two lending rates -- the central "refi" or refinancing and the marginal lending rates -- are also at all-time lows at plus 0.05 percent and plus 0.30 percent respectively.

This means that the interest rates bank charge customers are also extremely low, making it attractive for households and businesses to borrow money for, say, purchasing a house.

At the same time, interest rates close to zero are a bane for savers, because of the very low interest paid on clients' saving accounts.

If banks do eventually pass on their extra costs to their customers and charge them to safeguard their cash, savers may be tempted to take their money out of the bank and invest it in other assets, such as bonds or stocks, or simply bring it home and keep it under the mattress.

 

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