What in the World are Negative Deposit Rates?!

If you’ve been a good student in our School of Pipsology, you’d know that a country’s interest rate is one of the biggest factors that determine the value of its currency. This is why traders usually keep tabs on central banks’ monetary policy biases, as well as economic data that could influence interest rate expectations.

More often than not, when there’s an interest rate hike or when traders are expecting one, demand for that country’s currency rises and so does its value. On the other hand, when a central bank cuts rates or is expected to do so, demand for their currency drops along with its value. This is because the central bank’s benchmark interest rate dictates the rate of return for holding that country’s assets.

Just this week, ECB officials caused quite a ruckus in the markets by saying that they are considering negative deposit rates. This isn’t the first time that this issue has been brought up, as ECB Governor Draghi talked about negative rates back in June. How in the world is that supposed to work?!

Positive deposit rates mean that local banks get a small return for storing some of their cash reserves with the central bank. By implementing negative deposit rates, a central bank would end up charging banks for keeping cash stored in their vaults. In other words, having negative deposit rates would discourage local banks from keeping more cash lying around instead of lending it out.

Of course changes in deposit rates also tend to have an impact on overall interest rates. You see, when banks can no longer earn returns from keeping cash with the central bank, they are likely to seek gains elsewhere. And with more cash to lend to individuals and businesses, banks won’t mind charging lower loan rates just to encourage more borrowing.

With banks getting smaller profits from lending money out, they could wind up offering lower returns on their investment products and securities. In effect, this would drag down average interest rates in the country, eventually resulting to weaker demand for its assets and currency.

The potential impact isn’t always as straightforward though, as some naysayers argue that local banks could simply pass the cost of negative deposit rates to consumers. If that’s the case, banks would end up charging higher loan rates and therefore discourage borrowing activity. This is probably one of the potential repercussions that FOMC official James Bullard is worried about when he mentioned that the Fed should study the impact of negative deposit rates.

How about you? Do you think that negative deposit rates will be an effective monetary policy move? Share your thoughts in the comment box below!

  • etfak

    Once again, banks will rather keep all the money for themselves for trading high-yielding instruments than passing them straight forward to the real economy with the excuse of supporting growth by strengthening stock exchanges’ companies. Been there, seen that.

    So, no matter one is still being in any business or not, trading should be a must-do job. Good luck to us all!

    • Forex Gump

      Yeah that’s really a strong possibility. Do you think that scenario is long-term bullish or bearish for a currency though? Or no impact until we see the negative repercussions on lending and growth? This is a pretty interesting discussion so I’d like to keep it going. Thanks for sharing your thoughts!

      • etfak

        Negative rates cannot be bullish for any currency, they are definitely bearish.
        Personally i am short on EURUSD even though Draghi recalled the negative rates policy in another speech last night.

        • Forex Gump

          Talk about getting mixed signals from Draghi, huh? I agree that fundamentals line up for a short EUR/USD position though, especially with the Fed likely to taper sooner or later. Just having trouble figuring out where EUR/USD would turn and start heading south.

  • loliviersr

    Assuming that banks don’t pass the cost of negative rate to consumers, low borrowing cost could stimulate consumer demand and business expansion, which could generate economic growth within the zone. Therefore, we should wait and see the impact of negative deposit rates.

    • Forex Gump

      I’m inclined to wait and see as well! As mentioned by etfak above, it’s likely that banks will just keep the money for themselves instead of actually lending more out. Might be better to react rather than anticipate then. Thanks for sharing your thoughts!

  • WaterWay

    key point to make:
    – capital would be spread down the (local) chain IF money were not allowed to leave the protectorate.
    SNB experience shows that
    18th Century ideas doesn’t work in globalised economy.
    Today, cash doesn’t have borders and can be easily dispersed in the NIKKEI,MISEX,IBOV to name a few …

    Building up Delusionary pressures into the market guess-work, has proven to be much more effective and cheaper then any liquidity program.

    • Forex Gump

      Hmm interesting. It does look like managing/changing market expectations, especially through comments from central bankers, is playing a bigger role even in price action for now. Thanks for bringing up that instance with the SNB, I’ll look more into that. Do you think that an actual announcement of negative rates won’t have much of an effect on the euro then?

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  • Hm, the intent is 100% there , but as said it depends on how the individual banks react to it. They are not forced to go looking for other ways of making money.
    Im just gonna go off-topic for a sec cos i need to share this after checking the newsletter poll. It wouldnt let me since i didnt fill in enough (since i didnt have more to say so ill say it here)
    Articles like these are why i keep coming back to babypips, that, and the reactions to it by people who know a lot, and some of the forum threads if its not about automated systems. Probably the reason why babypips is the only newsletter on forex and finances i care to read.
    Sorry for the off-topic but i just had to pass my five cants and kudos on the great work.
    Safe tradings …

    • Forex Gump

      Thanks for the really kind feedback, alleycat! We’ll definitely try to keep coming up with good quality articles and lessons that’d be helpful and informative for our readers. Of course, we’ll keep finding ways to improve our content as well. If you have any additional suggestions, feel free to let us know. See you around!

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