Interest rates in the UK have been at a record low of just 0.5 per cent for seven years. That has brought welcome relief for mortgage borrowers but proved painful for savers. But imagine a world where savings accounts generate no income and your mortgage lender pays you to borrow! Sound far-fetched? Well some lucky people in Denmark are actually earning interest on their mortgages. That is because interest rates have turned negative in that country, as well as in various other parts of the world.
For economists this is not quite like discovering that the world is, after all, flat, but it has come as a shock. Policymakers have long used interest rates as an economic medicine, raising the cost of borrowing before growth and inflation becomes feverishly high and lowering it when the economic pulse weakens. This treatment worked pretty well until the global financial crisis, which laid the global economy so low that central banks around the world adopted extraordinary measures, including negative interest rates, to revive the patient.
So why do negative rates matter?
Theoretically, when rates fall it should raise the appeal of financial assets such as equities. However, the euro zone has had negative rates since June 2014 and Switzerland since December 2014; yet equity markets in both regions are down since then.
So, does this mean negative rates are not working, not working yet or have resulted in a better situation than would have otherwise been the case? The truth is that no one knows for sure, but it is reasonable to assert that negative rates are not instilling confidence in investors, who are interpreting them as a sign that conditions are far from normal.
Given this uncertain environment, it is not hard to see why savers and investors will continue to seek comfort in ‘safe’ assets, such as bonds issued by various governments, for a prolonged period, despite the paltry returns on offer.
Senior Economist (UK and Europe) Aviva Investors
Stewart is responsible for economic research and analysis of the UK and main European markets, working alongside the other economists in the Strategy Team.
He joined the investment industry in 1993 and Aviva Investors in March 2005.