Summary

● In view of the unprecedented global economic crisis triggered by the COVID-19 pandemic, some central banks are weighing the option of adding the NIRP in their policy toolbox as they have reached their limits of monetary easing.

● Considered unconventional, in the aftermath of the Global Financial Crisis and with policy rates nearing the zero lower bound, some central banks have applied NIRP to either stimulate inflation or weaken its currency.

● The pass-through of NIRP was clear in the money market (overnight interbank rate shifted down similar to when central banks were executing conventional rate cuts) and debt market (negative-yielding bonds account for about 20-25% of worldwide government bonds), but rather limited from the deposit perspective (corporate and household deposit rates have mostly remained positive, with household deposit rates exhibiting some downward rigidity).

● The transmission of NIRP was limited via the lending channel (no evidence of an expansionary impact on the amount of loans), but more apparent via the exchange rate (domestic exchange rate depreciated due to the large net outflow of money) and portfolio rebalancing channels (investors switched to riskier assets with higher expected returns).

● In a risk-on mode, there is a relatively higher probability of funds moving out from a market that adopts NIRP into emerging market high yield assets. However, the relocation of risk trade would likely be into a less volatile asset class or EM’s government bonds.

● The typical expansionary effects of rate cutting have been partially capped by the unintended consequences of NIRP, such as low inflation expectations, shrinking bank margins and cash hoarding.

Introduction

● Negative interest rate policy (NIRP) is back in the limelight as ammunition-exhausted central banks deliberate on mechanisms to enhance monetary easing in weathering the economic downturn triggered by the COVID-19 pandemic.

- Some central banks (e.g. Federal Reserve, Reserve Bank of Australia) have publicly opposed the idea of going below zero, while others continue to keep it as an option (e.g. Bank of England, Reserve Bank of New Zealand).

● This report aims to act as a primer on the NIRP by diving into the origins, impacts and risks associated with the unorthodox monetary policy, as experienced by economies that have already adopted the NIRP.

Emergence of NIRP

● In the aftermath ofthe 2007-2008 GlobalFinancialCrisis, the advanced economieswere caught up in an environment of hampered growth and subdued inflation.

- With limited fiscal space and policy rates nearing the zero lower bound, central banks of major advanced economies resorted to introduce new, unconventional monetary policy instruments, ranging from asset purchases programmes, forward guidance, lending operations and NIRP.

● NIRP was first adopted in 2012 by the Danmarks Nationalbank(DNB). Since then, the European Central Bank (ECB), Swiss National Bank (SNB), Riksbank(RB), Bank of Japan (BOJ) and Hungarian National Bank (MNB) have followed suit.

- Of the total six central banks, one central bank (RB) has left the negative rate territory in December 2019, after five years of implementing the NIRP, marked by its achievement of meeting the inflation target.

- Notably, these central banks embarked on the unchartered route of negative rates with varying end-goals and some variations in the implementation mechanism of NIRP, as illustrated in the table below.

Source: Kenanga Research - 13 Jul 2020