Economists from the Bank of International Settlements (BIS), widely dubbed “the central bankers’ central bank,” have issued a warning that should central banks in Europe and Japan continue to cut interest rates into negative territory for much longer, this unconventional monetary policy will backfire.
The cautionary statement summarises research by BIS, published on Sunday 6th March (and timed to be digested before the European Central Bank’s next policy meeting on the 10th), warning that should rates fall further below zero or remain negative for a lengthy period, the response by individuals and financial institutions will be unpredictable.
For currency watchers, cleaving to their tried-and-tested Forex trading strategies might be the best means of managing turbulence and unpredictability on the Forex markets. However, intensified turbulence and unpredictability there will be, according to BIS, if monetary policy continues in this direction.
Markets expect the ECB to drive its deposit rate deeper into the negative zone on Thursday, slicing 10 basis points to bring it to minus 0.4 percent, in an effort to ward off deflation. The policy is not without its critics: banks have been warning that it is short-sighted to deliberately weaken currencies, while investors have protested that banks are left having to foot too much of the bill for what is an entirely experimental policy.
The BIS study points to some unexpected effects of the policy: retail deposits have been insulated, while a number of mortgage rates in Switzerland have “perversely increased.”
BIS economists Morten Bech and Aytek Malkhozov said “If negative policy rates do not feed into lending rates for households and firms, they largely lose their rationale.
“On the other hand, if negative policy rates are transmitted to lending rates for firms and households, then there will be knock-on effects on bank profitability unless negative rates are also imposed on deposits, raising questions as to the stability of the retail deposit base.”