Historically, we had the lowest global interest rates following the global financial crisis of 2008 and 2009. Since then, slow recovery has prevented it from going back up to previous levels. With the EU referendum last June, fresh fears have further applied pressure to push interest rates even further down into negative territory. As a result, negative interest rates can affect the currencies of those nations.
Negatives interest rates have persisted in Denmark, Germany, Japan, and Switzerland and this phenomenon is expected to continue. The negatives rates in these countries have seen the value of their currencies depreciate concurrently.
A lot of the time, it’s the central banks that conduct unprecedented measure to create inflation in these countries to devalue the currency and encourage investment. But at times, inflation hasn’t had the desired effect as a result of excess capacity in those markets.
When a central bank increases the supply of money, it automatically devalues the currency relative to lets the US dollar or the sterling pound. The oversupply of money sets interest rates falling and this reduces the global demand for securities denominated in the local currency.
Diminished value of a currency can boost exports and this can stimulate growth in export economies. But at the same time, if you’re importing a lot of goods, it can have a devastating impact because foreign products will be more expensive.
A good example is China as they devalue their currency often to stimulate exports. Two years ago, The People’s Bank of China set its interest rate at 6% and now it’s down to 4.4% showing the correlation between currency devaluation and interest rates.
Negatives interest rates are still quite an odd proposition as lending decisions can seem to be violated. What this means is that the creditor is losing capital while taking on counterparty risk. But as there’s uncertainty surrounding the returns on other assets, investors keep seeking out these low-risk securities.
It’s hard to say what the long-term impact of this will be as low-risk assets don’t stimulate the economy. Further, consumers, businesses, and banks holding on to a lot of cash can be punished by lower rates.
But if you look at the countries in Europe with negative interest rates, savings rates have risen despite the current circumstances. Further, even though the currency was devalued, inflation has been slow to rise as a result of low industrial capacity and high unemployment.
So even if trade can be boosted by having a cheaper currency, these countries may not have the capacity to meet the demands of global trade.