Exploring Negative Interest Rates

Canadian interest rates are low – but could they go even lower? Could we reach a point where we have negative interest rates – whatever those are exactly? That has been the question since the concept of ‘negative rates’ hit mainstream conversations last year. Negative rates have since been adopted by some countries and there have been hints that Canada could experiment with them as well.

Let’s start by defining negative interest rates. As much as they sound like something that would be great for the housing market, they are actually a policy tool aimed at changing the behavior of banks rather than individuals. Their purpose is to boost economic activity, and in the process, avoid ‘deflation’ or falling prices.
The best example of this can be found in Japan, which has long had a deflation problem and last year adopted negative rates. The Bank of Japan (BOJ, the country’s central bank) wants the country’s chartered banks to lend to businesses and consumers, so rather than give them any interest on money deposited with the BOJ they instead are now actually charging them for leaving the money parked. Effectively, this means that long term interest rates are lower (in this case negative) and in turn the banks are likely to pass on the lower rates. In Japan, this has already benefitted the housing market in that it has led to all of the country’s major banks cutting mortgage rates to customers.

As much as there are positives to lower interest rates, they have their downside as well. As a recent analysis by the San Francisco Federal Reserve points out, moving to negative rates can hurt bank profits, which is not something a central bank, and in particular the Bank of Canada, should be cavalier about. Banks typically have a ‘spread’ between what they pay on deposits and what they earn on loans. If they have to pay interest on their own deposits, that would weigh on bank profitability unless the banks manage to pass on the costs to their customers.
As well as Japan; Sweden, Denmark and Switzerland have also moved into below-zero rates.\At a press conference in December, Bank of Canada Governor Stephen Poloz hinted that it was a tool he would consider. More recently, a February analysis by Citigroup said the prospect of Canada heading into negative interest rates was ‘material’.

So would negative interest rates be a good thing for the housing market? The answer is maybe and contingent on a scenario in which things were stalled and it was the only way to move things forward. Better still, however, would be to keep building a strong economy with a banking sector that is confident about lending and households that feel secure about borrowing.

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