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MONETARY POLICIES

Is the Influence of the Central Banks Fading?

Influence, Central Banks, Fading, interest rates, Monetary Policies, fx trader, forex

We’re in a world of negative interest rates - it’s a reflection of the unpredictable state of the global economy. But at a time when anxiety surrounding the slowing rate of global economic growth - causing many major central banks to take bold action - traders need to start consider the effectiveness of monetary policy tools and the impact they might have on the long-term fundamentals.

Put another way, we need to question whether the central banks are close to running out effective levers to stimulate stagnating economies. Imposing negative interest rates can certainly be described as unorthodox - and could be viewed as a sign that central banks now need to take extreme policy decisions to have any meaningful effect.

What are negative interest rates - and why are they being used?

As traders know, interest rate decisions from major central banks can cause significant market movements - simply because interest rates are an indicator of the health of an economy. For the best part of the last decade, interest rates have been close to zero across the major economies to encourage consumers and businesses to borrow money (mortgages and loans) and spend to boost economic growth. This has been a response to the global financial crisis of 2008, where the global economy was subject to a substantial slowdown.

Negative interest rates are a further extreme of this kind of thinking, where central banks will actually charge commercial banks for holding reserves with them (also known as a key deposit rate). The intended effect here is to make commercial banks lend more to consumers and businesses.

At the time of writing, negative interest rates are in place in five major economies: Japan, Switzerland, Eurozone, Sweden and Denmark. Let’s take a look at some examples.

Bank of Japan

In Japan, the interest rate is -0.10% but this is on a tiered system. The three-tier system means that basic balances still earn 0.10%. However, reserves above a certain threshold that commercial banks keep at the central bank receive zero interest. Then above the second threshold, the commercial bank will have to pay the central bank 0.10% (i.e. -0.10% interest rate) to hold the reserves.

The negative interest rate applies to current accounts held by financial firms at the central bank as part of a three tier rate system. Approximately ¥10 trillion to ¥30 trillion of the ¥250 trillion currently held in these accounts are subject to the -0.1% rate.

The three-tier system makes the move somewhat weaker than comparable actions by the European Central Bank and other European central banks. The Bank of Japan will only pay negative rates on new bank reserves resulting from its programme of asset purchases. All existing bank reserves - which amount to about $2.5 trillion or 50% of gross domestic product - will continue to be paid interest at 0.1%.

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