Negative rates: is the cure worse than the disease? - Capital Economics
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Negative rates: is the cure worse than the disease?

Global Economics Focus
Written by Jennifer McKeown
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Negative policy rates have had some positive effects in the economies where they apply and the direct adverse consequences have been small. But the policy has contributed to a fall in long-term interest rates which is doing greater damage to banks’ profits and may be having the perverse effect of raising household savings. Interest rates might be cut a little further below zero, but we doubt that this would do any good.

  • Negative policy rates have had some positive effects in the economies where they apply and the direct adverse consequences have been small. But the policy has contributed to a fall in long-term interest rates which is doing greater damage to banks’ profits and may be having the perverse effect of raising household savings. Interest rates might be cut a little further below zero, but we doubt that this would do any good.
  • As global growth has remained subdued and inflation very weak, several central banks have resorted to cutting interest rates below zero. Denmark led the way in 2012, the euro-zone followed in 2014, Sweden and Switzerland in 2015 and then Japan in 2016. With a record 25% of the global bond market already negative-yielding, hints that rates might be cut even further have been met with scepticism in some quarters.
  • Negative rates appear to have had at least some of the intended consequences. Interest rates on bank loans have fallen, as have government and corporate bond yields, benefitting borrowers. In the euro-zone, Sweden and Denmark, cuts into negative territory seem to have been as effective at reducing borrowing costs as those from above zero. Lending growth has risen since negative rates were imposed, albeit quite slowly and not by more than in countries where policy rates are still positive such as the US.
  • But other objectives have not been achieved. If anything, inflation expectations have fallen since negative rates were introduced, possibly reflecting a sense that central banks have reached their limits and lost the battle to raise prices. What’s more, small cuts into negative territory have done very little to influence exchange rates, especially in Switzerland and Japan where safe-haven effects have dominated.
  • As for the adverse effects, fears that negative interest rates would cause an immediate flight to cash have so far proved unfounded. This may be because retail deposit rates have typically not turned negative and storing and transacting in cash is costly. Meanwhile, the direct effect of negative deposit rates on banks’ profitability has been small since the fees on their reserves are minor compared to the size of their assets.
  • But low long-term interest rates and flat yield curves have had a much bigger impact on banks’ profitability and on pension funds’ and insurers’ ability to meet their obligations. Sooner or later, this will affect firms and households either through tighter lending criteria or lower returns and reduced payouts.
  • Fears of a run-up of debt or overheating of housing markets have mainly proved misplaced. On the contrary, households in some countries have built up their savings. This might be a reaction to uncertain economic conditions, but it is possible that they are responding to the decline in long-term interest rates by saving more to ensure their retirement income. If so, monetary policy is becoming counter-productive.
  • The decline in long-term rates and flatness of yield curves is not a direct consequence of negative policy rates and one might argue that further rate cuts now would serve to steepen yield curves. But it seems more likely that interest rate cuts at this stage will strengthen the impression that central banks do not have enough ammunition in the fight to raise inflation and that policy will need to stay loose indefinitely.
  • It is worth noting that quantitative easing and enhanced forward guidance would also serve to lower long-term interest rates and the costs of this may be starting to outweigh the benefits. In Europe and Japan at least, monetary policy is near its limits. While further rate cuts and asset purchases are likely, they will be small and ineffective. Only a significant fiscal stimulus would boost growth, raise inflation and steepen yield curves in a way that would have benefits throughout the economy. Since governments are apparently unwilling or in some cases unable to deliver this, growth and inflation in advanced economies looks set to remain very weak over the next few years.

Negative rates: is the cure worse than the disease?

Far from being a temporary emergency measure, it seems that negative interest rates are here to stay. And with some central banks now hinting at cuts deeper into negative territory, questions are resurfacing about whether the benefits will outweigh the costs. In this Focus, we start with some background about negative rates and how prevalent they have become. Then, we assess whether they have had the desired effect. Third, we analyse the adverse side effects and consider steps that might be taken to mitigate them. And finally, we outline our expectations, stating which banks seem likely to cut interest rates further below zero and what impact this is likely to have.

How prevalent are negative rates?

As global growth has remained subdued and inflation very weak, several central banks have resorted to cutting their short-term policy rates below zero. Denmark’s Nationalbank led the way in 2012, the ECB followed in 2014, the Swiss National Bank and Swedish Riksbank in 2015 and the Bank of Japan at the start of 2016. (See Chart 1.) Details of the various rates, when they were applied and to what they apply are in Table 1.

Chart 1: Policy Rates (%)

Source: Refinitiv

When they were first imposed, negative interest rates were assumed by many (but not us!) to be a temporary emergency measure. But the experience of the past five years has suggested that they are a more lasting feature. What’s more, some central banks seem to be preparing the ground for further cuts. The ECB altered its forward guidance at its meeting in July to state that it expected “interest rates to remain at their present or lower levels [our emphasis] at least through the first half of 2020”. The Bank of Japan stated at its meeting just a week later that it was prepared to loosen policy if momentum towards the inflation target was lost. Two members dissented, apparently in favour of loosening policy immediately policy. US interest rates are higher, at 2% to 2.25%. But the Fed has begun an easing cycle and it has tended to cut rates by between 4% and 5% in previous downturns. So if the economy slowed by more than our forecasts imply, cuts below zero might not be infeasible.

Table 1: Details of Negative Policy Rates

Central bank and date introduced

Negative rate

Scope

Denmark Nationalbank (Jun. 2012 & Sep. 2014)

-0.65%

(certificates of deposit rate)

Charged on reserves above an upper limit on current account holdings. Equivalent to DKK135bn (7% of GDP).

ECB
(Jun. 2014)

-0.4%

(deposit rate)

Applies to “excess” reserves, which total €1760bn (15% of GDP).

Swiss National Bank
(Jan. 2015)

-0.75%

(policy rate)

Applies to reserves more than 20 times larger than minimum required reserves. Currently CHF110bn (17% of GDP).

Sweden Riksbank
(Feb. 2015)

-0.25%

(repo rate)

Applies to 95% of “excess reserves”. Penal deposit rates of -0.35 and -1% apply to tiny amounts of particularly liquid funds. (Total is 3.5% of GDP).

Bank of Japan
(Jan. 2016)

-0.1%

(interest on policy rate balance)

Different rates paid on 3 tiers of reserves, with negative rates on reserves beyond a high threshold. On net BoJ still pays banks positive interest on reserves.

Sources: Central banks, Capital Economics

As a record 25% of the global bond market is already negative-yielding, there are understandably major concerns over how any further steps into the unknown will affect the economies and banking sectors in question. Indeed, many have argued that the cure of negative rates and the implications for bank profitability might well be worse than the disease of slow growth and low inflation.

How effective have negative rates been?

Leaving any adverse effects aside for now, it is important to ask whether negative rates have yielded the benefits that were intended. There are four channels through which central banks might have hoped that negative rates would work: by reducing borrowing costs; by stimulating borrowing and spending; by raising inflation expectations; or by weakening the currency.

The policy appears to have had the desired effect on borrowing costs. Charts 2 and 3 show that interbank lending rates in both the euro-zone and Sweden have moved down in lockstep with official interest rates.

Chart 2: Policy Rates & Interbank Rate (%)

Source: Refinitiv

Chart 3: Swedish Policy Rates & Interbank Rate (%)

Source: Refinitiv

The reduction in official rates has served to reduce banks’ lending rates to their customers. Chart 4 shows the example of the euro-zone, where cuts in the deposit rate into negative territory appear to have been as effective in reducing borrowing rates as those from above the zero line in 2009 and 2012. But it is worth noting that the modest cut in the Japanese official rate has had a relatively small impact on average bank lending rates.

It is also important to point out that, with a rare few exceptions, commercial banks have not passed negative deposit rates on to their own customers. Charts 5 and 6 illustrate this for Japan and Sweden, where the stickiness in retail deposit rates has been most apparent. But average retail deposit rates in the euro-zone, Switzerland and Denmark have also remained marginally positive.

Chart 4: ECB Policy Rate & Bank Lending Rate to the Private Sector (%)

Source: Refinitiv

Chart 5: BoJ Policy Rate & Japanese Retail Deposit
Rate (%)

Source: Refinitiv

Chart 6: Riksbank Policy Rate & Swedish Retail Deposit Rate (%)

Source: Refinitiv

This might feel like a benefit to the average person. Indeed, the German finance minister has proposed making negative retail deposit rates illegal to avoid public discontent and a loss of voter support. But if negative rates are not passed on to households, then policy rate cuts below zero cannot dis-incentivise saving as much as cuts in positive territory. The stickiness of retail deposit rates has also added to pressure on banks’ profits, which we will explore later.

There is perhaps some evidence to suggest that rate cuts below zero have supported lending growth. Chart 7 shows that lending growth has increased somewhat since negative interest rates were imposed in the euro-zone and Switzerland. But there appears to have been little impact in Japan. And it’s worth noting that lending growth in the US, where policy rates have remained positive, is considerably stronger than in any of these economies.

Chart 7: Bank Lending to the Private Sector (% y/y)

Source: Refinitiv, S&P

It’s worth a brief diversion here to note that there is nothing so far to suggest that we have reached the tipping point referred to as the “reversal rate” in a 2019 paper by Brunnermeier and Koby. The theory goes that once policy rates fall too far, banks will respond to the cost of fees on their reserves by either raising their own lending interest rates or cutting the volumes of loans. But we will return to the adverse consequences of negative rates later.

As for other intended consequences, government bond yields have clearly fallen, in many cases into negative territory. (See Chart 8.) Admittedly, the decline in bond yields has not been entirely due to falling official rates – quantitative easing and growing risk aversion have played a role too. And the decline in bond yields has had some adverse implications for the financial sector, to which we will also return later. But for the governments in question, the reduction in their debt servicing costs will have been welcome. It should have supported growth by making fiscal policy less tight than it otherwise would have been.

Chart 8: 10-Yr Government Bond Yields (%)

Source: Refinitiv

Corporates have also seen a reduction in their direct borrowing costs. Charts 9 and 10 illustrate this for the euro-zone and Sweden, where corporate bond yields have been as responsive to cuts in official rates below zero as they were to cuts from above that level. The same applies to Switzerland and, to a lesser extent, Japan. Corporate bond yields are still positive (except in Switzerland), but they have reached record lows.

Chart 9: ECB Policy Rate & Euro-zone Investment Grade Corporate Bond Yields (%)

Source: Refinitiv, S&P Global

Chart 10: Riksbank Policy Rate & Swedish Investment Grade Corporate Bond Yield (%)

Source: Refinitiv, S&P Global

But while borrowing costs have fallen and lending growth has perhaps been boosted a little, the third objective of raising inflation expectations has not been achieved. Chart 11 shows market-based inflation expectations for the US, euro-zone and Japan. They have drifted down in the latter two since negative rates were imposed and they are significantly lower than in the US. In both cases, medium-term inflation expectations are still far below the central banks’ 2% targets.

Chart 11: Inflation Expectations (%)

Source: Refinitiv

Swedish and Swiss financial market inflation expectations are not readily available. But based on national surveys, neither have risen markedly. In Sweden, inflation expectations rose above 2% during a period of economic strength in 2017/2018, but they have fallen again recently. In Switzerland, they have edged up only slightly, to just 0.5%.

Admittedly, inflation expectations might have been even lower had it not been for the reduction in interest rates below zero. But we suspect that the cuts have served more to highlight central banks’ inability to get inflation up to target than to convince firms, households or financial market participants that inflation will be stronger than it otherwise would have been.

Meanwhile, exchange rates have not responded strongly to cuts in official rates below zero. Chart 12 shows that the Japanese yen continued to appreciate after negative rates were imposed in 2016. This was in contrast to the depreciation which followed the announcement of further quantitative easing in 2012.

And while negative interest rates appeared to cause some depreciation of the euro, again the announcement of quantitative easing seemed to have a more powerful effect on the exchange rate. (See Chart 13.) This implies that, to the extent that monetary policymakers would like to engineer a depreciation of their respective currencies, then asset purchases would be a more effective way to achieve this than further modest interest rate cuts.

Chart 12: Trade-weighted Yen

Source: Refinitiv

Chart 13: Trade-weighted Euro

Source: Refinitiv

How much damage has been done?

So the evidence on whether negative interest rates have achieved central banks’ objectives is mixed. But what of the adverse effects? We can think of four key sources of damage, some of which relate directly to the negative policy rate and some to the associated decline in long-term yields and flattening of yield curves. Negative rates might cause a flight to cash; they might damage banks’ profits; they could prevent pension funds from providing a return; or they might cause households to save more to insure a certain retirement income.

Before negative interest rates were introduced, many believed that they would provoke a flight to cash as firms and households removed their money from banks and stashed it under the mattress. As well as causing serious problems for the banks, this would reduce the effectiveness of monetary policy by limiting the central banks’ influence over firms’ and households’ behaviour. At the time, we estimated that the costs of storing and transacting in cash were between 1% and 2% and therefore argued that interest rates would need to fall below -1% to provoke such a response. (See Global Economics Focus, “Are negative interest rates effective?”, 23rd October 2015.) This could be thought of as the floor for interest rates or the “effective lower bound”.

Our judgement seems to have been broadly correct. Chart 14 shows that the advent of negative interest rates (which were first introduced between April 2014 and January 2016 in this group of economies) did not provoke a sudden spike in cash use relative to GDP.

Chart 14: Notes and Coin as % of GDP

Source: Refinitiv

There is some evidence of a general upward trend in Japan, Switzerland and (until recently) the euro-zone. But this began before the advent of negative policy rates and has also been apparent in economies where interest rates have not turned negative, most notably the US.

In papers published last year[1], the ECB and the Bank for International Settlements both highlighted this trend and put it down to two factors. First, the global financial crisis has reduced trust in the banking sector and encouraged people to hold some of their assets in cash. Second, the steady decline in returns on assets has reduced the opportunity cost of holding cash. We suspect that policy rates would need to fall below -1% and that commercial banks would need to start passing this cost onto their own depositors before we would see the kind of mechanical flight to cash of which some commentators warned.

Another major concern was that negative interest rates would damage banks’ profitability. The negative deposit rate imposes a direct cost on commercial banks as they are forced to pay a fee to the central bank for any reserves above a certain level. The level at which the negative rate kicks in varies by country and is described in Table 1 on page 2. Bank reserves have risen dramatically in these economies as a result of the central banks’ quantitative easing programmes. Nonetheless, the reserves that are subject to fees are still fairly small as shares of GDP. And given that the negative interest rates are also small, the costs are typically lower than 0.1% of GDP. (See Chart 15.)

Chart 15: Annual Cost of Negative Interest for Banks
(% of GDP, brackets show rate of negative interest)

Sources: Central Banks, Refinitiv, Capital Economics

Switzerland is the only exception, where the direct cost of negative interest rates to commercial banks is now close to 0.2% of GDP annually. So to that extent, the effect of negative rates on banks’ profitability has been minor.

However, the decline in long-term yields and flattening (or even inversion) of yield curves has limited banks’ ability to raise profits by borrowing over short horizons and lending for longer. Chart 16 shows that banks’ profit margins have held up reasonably well in the euro-zone and Sweden despite all this. But they have fallen in Japan and Switzerland.

This raises the rather difficult question of whether negative policy rates can be held responsible for the more general phenomenon of depressed long-term interest rates and flat yield curves. One could argue that they are not to blame. After all, safe government bond yields have fallen around the world due to weak growth and risk aversion, not just where policy rates are negative. And the US yield curve has inverted despite the fact that policy rates have never turned negative. Arguably, a further reduction in interest rates (even if that takes them deeper into negative territory) should steepen the yield curve and thereby support banks’ profitability.

Chart 16: Banks’ Net Interest Income as a % of Assets

Sources: IMF, Refinitiv, CEIC

However, recent interest rate cuts have failed to steepen yield curves, perhaps because of the impression that monetary policy is reaching its limits. Central banks, particularly in the economies where policy rates are already negative, have made clear that the scope for further support is limited. Interest rate cuts have therefore been extremely small and often accompanied by a pledge to keep them low for longer. This has served to provide more policy accommodation by reducing borrowing costs at longer horizons. But it has thereby also increased the pressure on banks.

Pension funds and insurers have been hit even harder than banks by persistently low interest rates. They are often required to provide a certain return and are constrained to holding a given proportion of their assets in safe bonds. They have therefore struggled to generate the returns they need to meet their long-term liabilities. This problem has been particularly severe in Switzerland, where official rates and bond yields are lowest and where pension funds make up a relatively high share of the economy. (See Chart 17 and our Nordic and Swiss Economics Update, “Why ‘yield curve control’ wouldn’t work for the SNB”, 2nd July 2019.)

Another major concern about negative (and generally low) interest rates was that they might cause debt to rise too far or asset price bubbles to inflate. Aside from in some small economies, there has been very little evidence of this.

Chart 17: Assets in Pension Funds (% of GDP, 2018)

Source: BIS

In the euro-zone, firms and households are generally still deleveraging and there has been little or no evidence to suggest that negative interest rates are promoting a build-up of debt. Chart 18 shows that euro-zone corporate debt has fallen as a share of GDP since negative interest rates were imposed. Japanese private sector debt has increased, but it remains very low by international and historic standards. There is also no real evidence of bubbles inflating in property markets in the euro-zone or Japan. Admittedly, there are concerns in Switzerland and Sweden. Chart 18 shows that there has been a sharp increase in corporate debt in both economies since negative rates were imposed and the same applies to household debt.

Chart 18: Corporate Debt (% of GDP)

Source: Refinitiv

House prices have also risen by more than incomes in both countries. (See Chart 19.) The SNB has expressed some concern that this is due to banks seeking to boost their ailing profits by offering risky mortgage loans. But in Sweden’s case at least, the central bank has already had some success engineering a soft landing in the housing market through the use of macro-prudential policies.

Chart 19: House Price to Earnings Ratios (2015 = 100)

Source: Refinitiv

In fact, in what might seem like a perverse reaction, we are more concerned that low interest rates have caused savings to increase than that they have caused debt to rise. Chart 20 shows that household saving rates have risen in Japan, Sweden and Denmark since negative interest rates were imposed.

Chart 20: Household Saving Rates
(% of disposable income)

Source: Refinitiv

While the rate in the euro-zone has risen only slightly, there has been a more marked increase in Germany. This suggests that households are (understandably) becoming concerned about their likely retirement income given persistently low rates of return. In some countries at least, they appear to be saving more in order to counter this effect. This suggests that for some, low interest rates are having exactly the opposite effect of that which was intended. Again, this does not relate explicitly to negative policy rates, but to low rates of return over longer horizons. However, we have argued that the two are linked.

Table 2 overleaf brings together all of the positive and negative effects of negative interest rates that we have assessed so far and assigns a rough order of magnitude to each. An upward arrow implies a positive economic impact and downward the reverse. Two arrows mean that the effect has been relatively strong. And a sidewards arrow means we have found no convincing evidence of any impact.

The short point is that the effects have been very mixed and it would be unfair to claim that negative rates have done no good. Where there are adverse consequences, these tend to relate much more to low long-term rates than to the negative policy rates themselves. But we have argued that the two things are linked. And we suspect that if policy rates fall much further the costs will begin to significantly outweigh the benefits. Unless, of course, there are effective ways to ease the pain…

What can be done to mitigate the adverse effects?

One option to limit the damage to banks’ profitability and possibly also reduce the risk of a flight to cash would be to introduce (or enhance) a tiered system for negative deposit rates on commercial banks.

The Swiss National Bank and the Bank of Japan already have tiered deposit rates. The former allows banks to hold twenty times their minimum reserves before charging a negative rate, while the latter has a three-tier system in which less than 10% of reserves are subject to a charge. In both cases, the point is to reduce the average charge on reserves but not the marginal (deposit) rate. As long as the banking system has excess liquidity, it is the deposit rate which determines the overnight interbank rate and which therefore influences monetary conditions in the wider economy. But it is the average rate on all reserves which directly affects banks’ profits and this can be limited by tiering, potentially allowing central banks to provide more policy accommodation without further damaging banks’ profits.

Further tiering might be beneficial in Switzerland, perhaps with the negative rate phased in gradually for banks whose reserves are more than twenty times the minimum. But in Japan, more tiering would be unlikely to make any difference given that the costs of deposit charges are negligible already. (See Chart 15 again.) The big problem for banks is the flatness of the yield curve, which as we have discussed is only an indirect result of the negative deposit rate.

Table 2: Summary of Effects of Negative Policy Rates

 

Evidence

Comments

Positive objectives

   

Reduce borrowing costs

Borrowing costs have fallen and the impact has been as big as for rate cuts from above zero.

We might yet reach a “reversal rate” where banks raise their lending rate to make up for lost profits.

Increase inflation expectations

Inflation expectations haven’t risen.

Further ineffective loosening might foster a belief that policy is impotent, causing inflation expectations to fall.

Stimulate borrowing

Borrowing has picked up, but not very much.

See thoughts below re household savings.

Weaken currency

There is very little evidence to suggest that negative rates have weighed on currencies, partly because the cuts have been small and partly because central banks have acted in tandem with each other.

Quantitative easing seems to have a bigger impact on exchange rates.

Adverse effects

   

Flight to cash

The dip in rates below zero has not triggered a flight to cash. This may be because retail deposit rates are still positive on the whole.

There is a general uptrend in cash use, which would be exacerbated by further interest rate cuts – particularly if commercial banks cut retail deposit rates below zero.

Damage to banks’ profits

The direct effects of negative rates have been minor.

Low long-term rates and flat yield curves have done more serious damage. But negative rates may be partly to blame for this – the sense that central banks are out of ammo has supported expectations that policy will have to stay loose for the foreseeable future.

Pension funds cannot achieve their goals

Pension funds and insurers are clearly struggling, but not because of negative interest rates per se.

Low long-term rates are a serious issue, which may have been partly caused by negative rates (see above). Asset purchases could do as much damage as further rate cuts, or perhaps even more.

Households save more

There is some evidence of this effect in Germany, where concerns about pension income may be partly to blame for the rise in the household saving rate. Again, this relates mainly to low long-term rates and returns on assets generally.

See above.

Source: Capital Economics

It is much more difficult to address the more general issues of low long-term interest rates and flat yield curves, which have had the greatest adverse effects. The ECB has attempted to transmit some benefits of its negative rates to commercial banks through its longer-term refinancing operations. Banks have been able to borrow at very low or even negative interest rates on the proviso that they lend the money on to firms and households. They have given positive feedback about these operations, claiming that they have supported profitability. Indeed, this might be one reason why euro-zone banks’ profits have held up better than those elsewhere.

But the Bank of Japan’s yield curve control has been less successful. One aim of the pledge to keep long-term yields at zero was to keep an upward slope to the yield curve as short-term rates fell below that level, thereby giving banks an opportunity to make profit. But in practice, the target has been very difficult to defend, particularly as a global economic slowdown has weighed on bond yields elsewhere. Meanwhile, concerns about the domestic economy have made the BoJ reluctant to reduce its asset purchases in the way that would have prevented a further decline in long-term yields. As a result, the yield curve is still very flat and the BoJ appears to have effectively abandoned its 10-year yield target.

As far as financial stability risks are concerned, macro-prudential policies could be used to avoid a run-up of debt or bubbles in asset prices. But it is not clear that cuts in interest rates below zero add to financial stability risks any more than those from above that level. The opposite problem of low long-term rates encouraging households to save more is far more difficult to address.

Conclusions and what the future holds

The upshot of our analysis is that falls in interest rates below zero have had some of the intended consequences, but there are signs that the benefits are starting to be outweighed by the costs.

With some mitigating strategies, including tiering policy rates and offering generous loans to banks, we think that central banks can and will cut interest rates a bit further into negative territory. Chart 21 shows our forecasts for official interest rates in each of the countries where they are already negative. We suspect that the Swedish and Danish central banks will reverse the small rate hikes that they have implemented in the past few years. Meanwhile, the ECB looks set to cut its policy rate to -0.5% next week and the SNB will follow suit in 2020 as it grapples with a strong currency. Japan is an exception, where we think that the current policy rate will prove to be a floor for now given particular concerns about the banks.

Chart 21: Policy Rates Forecasts

Sources: Bloomberg, Capital Economics

That said, there are clear limits to the policy. We are unlikely ever to see a widespread reduction in retail deposit rates below zero and hence the potency of rate cuts will be limited. And if retail deposit rates were to fall below zero, we might well see a more rapid flight to cash, weakening the transmission of monetary policy to the wider economy still further. Meanwhile, there will continue to be objections to negative rates and their damaging effects on savers and banks. Whether or not such concerns are well-founded, they present a political barrier to aggressive interest rate cuts. So we think that the rates implied by our current forecasts will prove to be the floor.

It is worth adding here that we think it very unlikely that US interest rates will be cut below zero. This relates partly to the particular importance money market funds and the risk that negative rates would cause them to default. Current Fed officials have all shown very little enthusiasm for using negative rates.

Even where rates will be cut further below zero, such small cuts will do little to support the economy, so policymakers will need to come up with something else should conditions worsen. Some more asset purchases are likely, but the ECB is reaching regulatory limits. What’s more, since low long-term yields and flat yield curves have been key to banks’ declining profitability, central banks will hesitate to pull them down further.

What is really needed is fiscal boost. This would see governments making use of the slump in bond yields that negative interest rates and dovish forward guidance have provoked. And none of the countries analysed in this note (with the exception of Italy) is in a position where more borrowing would do more harm than good. For now, though, there is very little evidence to suggest that governments are prepared to do their part.

  1. “Payments are a-changin’ but cash still rules”, Bech et al, BIS Quarterly Review, March 2018.

    “Trends and developments in the use of euro cash over the past ten years”, Lalouette & Esselink, ECB Economic Bulletin, Issue 6/2018.


Jennifer McKeown, Head of Global Economics Service, +44 20 7811 3910, jennifer.mckeown@capitaleconomics.com