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Negative interest rates – Is that where we are headed?

This week, as many commentators predicted, we once again saw the Reserve Bank of Australia lower the cash rate by 25 basis points to a record low 0.75%. In its statement, the RBA made the decision to lower interest rates to “support employment and income growth and the provide greater confidence that inflation will be consistent with the medium-term target”. But how low will they go?

There is speculation that we may see negative interest rates in the coming year. Somewhat of a rarity, negative interest rates are seldom seen yet are currently in effect in Switzerland, Denmark, Sweden and Japan with a further twenty countries on Europe sitting on cash rates of zero.

So, what are negative interest rates?

Negative interest rates occur when rates that financial institutions apply to customers lending money or having it in savings falls below zero. In general, its uncommon for banks to apply negative rates to consumer products such as mortgages and transactional accounts. Rather, the central bank usually will charge retail banks to keep money on deposit with them.

Why have negative interest rates?

A compelling reason as to why the central bank may opt for negative interest rates is to encourage retail financial institutions to lend money to consumers and businesses instead of leaving the money on deposit and be charged interest. Thus, the banks therefore pass on the interest rate decrease by encouraging customers to borrow and discouraging them to hold their money in savings. The intended result – increased spending and stabilised inflation.

What are the Benefits of Negative Interest Rates?

  • Lower interest rates generally mean less interest required to be paid back on borrowed funds. Potentially the customer may be paid to borrow money from the bank.
  • Often the currency will weaken and therefore may attract more foreign tourists.
  • Companies exporting goods could benefit from a weaker dollar as Australian goods are cheaper on the foreign market therefore increasing the overall volume of exports

What are the Pitfalls of Negative Interest rates?

  • Negative interest may mean losing money if you hold funds in savings or term deposits.
  • The weaker dollar would mean travelling overseas may be more expensive.
  • Those who rely on income from savings and term deposits such as retirees may be negatively impacted.
  • Import businesses may find it much more expensive to buy goods from overseas due to a weaker dollar.

No one knows exactly where our rates will land but there is still talk of further cuts.  No matter what the end game will be, spare a thought for the folks in Argentina who currently have a central bank cash rate of 78%. That can’ be ideal.

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