What the UK interest rate rise means for bonds
The Bank of England’s decision to raise interest rates by 0.25% to 0.5% on 2 November has been...
Negative interest rates are not a new phenomenon, but they are quite rare. So when they became present in a number of economies in 2015-2016, they started to make the headlines.
Having already seen them enacted by the central banks of Switzerland, Denmark and Sweden, in an attempt to both stimulate economies and stop the rapid appreciation of their currencies, it was a surprise move by the Bank of Japan in January 2016 that set people talking. Could the same thing happen in the UK?
According to Azad Zangana, senior European economist at Schroders: “Negative interest rates are likely to be positive for bond investors, as most bonds have a strong relationship with policy interest rates. As policy interest rates fall (into negative territory or otherwise), the coupon from a given bond becomes more attractive, pushing the yield to maturity lower, and the price of the bond higher.
“For equities, the impact of negative interest rates is not as clear and differs for banks and non-banks. One reading of the use of negative rates is that the economy is in such a poor state that negative rates is the only way to avoid a worse outcome – for example, a recession. This signal could result in investors becoming more risk averse.
“In theory, if negative interest rates are passed on to non-banking corporates then most would be paid for taking out bank loans, making them more profitable, which should boost share prices. However in reality, negative interest rates may squeeze the margins of banks, which could eventually force the banks to pass on the costs to its customers through either higher fees, lower or negative interest rates on deposits, or charging higher interest rates for new loans.”
Commenting on the surprise move by the Bank of Japan, John Husselbee, head of Multi-Asset at Liontrust, said: “The implementation of negative interest rates on excess reserves held at the central bank marks the latest stage of ‘Abenomics’. Japan has been trying to escape deflation for more than a couple of decades and we believe that the measures introduced in late 2012 by Prime Minister Shinzō Abe represent the best attempt so far.
“This latest measure has been termed the ‘Kuroda bazooka’, in reference to both the Bank of Japan’s governor and the term that has been ubiquitously applied to Mario Draghi’s attempts to deploy monetary policy weaponry, including negative interest rates, in Europe. In both Japan and Europe, we may find that equity investors who hedge against the likelihood of ongoing currency weakness are best placed to benefit from any associated rise in market levels. The Japanese market has yet to be significantly re-rated and, while the economic headwind of slower global growth blows strongly, Japanese companies should see earnings benefit from lower commodity prices.”