The reason why some central banks have imposed a zero interest rate and the potential impacts to investors and borrowers if the same were to happen in Australia
In Germany, a government ten-year bond yields less than zero; its Investors actually lose money! Huh? What triggers a situation like this and could it happen in Australia?
Australians currently enjoy – or not, depending on their circumstances – record low interest rates. The prevailing cash rate is currently 1.5 % and some economists are suggesting it could go lower.
Many of the world’s economies have been there-done that. Their central banks have made the decision to explore previously uncharted territory: the sub-zero interest rate zone.
So why would anyone buy an investment with a negative return? The short answer is that most wouldn’t.
This is exactly why central banks impose negative interest rates: the idea being to influence investors into putting their money elsewhere – equity, for example – in the hopes of triggering economic growth.
It’s a risk, though, because negative interest rates often slow the economy as people tighten their belts – particularly those relying on investment income, like retirees.
Negative interest rates present a previously unexplored world to Australian banks; their business is to lend money at a higher rate than the return they pay investors. If the lending rate is below zero, what could they possibly offer on deposits?
Nothing really. For example, if an investor deposits, say, $50,000 with a bank, in a year’s time he or she will still have $50,000; the cash balance will have neither increased nor decreased. Except for the security risk, it would be just as well off under the mattress.
This might explain why a Japanese company that manufactures domestic safes reported a rush on its product shortly after Japan went negative in February 2016!
To satisfy shareholders, banks will need to recoup their losses and will consider ways of doing this which may include increasing the cost of borrowing through higher fees and charges.
For Mr and Mrs Australian, while their mortgage may appear cheaper to service because they’re paying less interest, the cost of setting it up, and the ongoing administration charges could take up the slack.
Australia’s economy is still cool which may prompt the Reserve Bank of Australia (RBA) to decrease the cash rate below current levels in an effort to stimulate it. In this event, we may also find ourselves in sub-zero climes.
Even so, it’s not a foregone conclusion. If our market warms and inflation begins to rise, our current downward slide will be halted. If the upward movement becomes a trend, interest rates will rise and investors will be popping the bubbly.
Interest rates are not static creatures; they are easily influenced and can influence in their turn. Your financial adviser can show you how it’s possible to ride these ups and downs.
According to Fortune.com, countries that have taken the sub-zero-rate approach are reporting a lack of confidence among householders. But for Australians it’s not all doom and gloom. We have the advantage of these countries’ experience.
With the right advice, that advantage is in your hands.