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13th February 2016

Negative interest rates – negative for savers but positive for investors?

In 2015, the talk was all about when interest rates would finally rise. In 2016, however, the direction of central bank policy seems to have gone into reverse and conversation has now turned to negative interest rates.

The central banks of Switzerland, Denmark and Sweden have had interest rates in negative territory for some time in an attempt to both stimulate economies and stop the rapid appreciation of their currencies.

In a surprise move last month, the Bank of Japan followed suit and expectations are that the European Central Bank could head further into negative territory next month. Emergency levels are being moved to even more emergency levels!

Could the same thing happen in the UK? Quite possibly. And what would it mean for savers and investors?

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 are squeezing the margins of banks, which will 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.

“The evidence so far suggests some charges are being passed on to corporates, but not to households. Meanwhile, over the past few weeks banking stocks (which make up a substantial share of UK and European equity markets) have been very volatile on the back of concerns that banks' profits are being squeezed by central banks.

“Central banks appear to be targeting weaker currencies with the use of negative interest rates. If a country's currency weakens against its main trading partners, then shares in exporting companies should perform well due to the boost to overseas earnings.”_

Commenting on the surprise move by the Bank of Japan, John Husselbee, head of Multi-Asset at Liontrust, said: "The recent 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.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are opinions only and do not constitute financial advice.

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