When interest rates are high, people borrow less and save more. When they’re low, savings go down and borrowing goes up. But what happens when rates stay negative?
In Denmark, where rates have been below zero longer than anywhere else on the planet, the private sector is saving more than it did when rates were positive (before 2012). Private investment is down and the economy is in a “low-growth crisis,” to quote Handelsbanken. The latest inflation data show prices have stagnated.
As the Danes head even further down their negative-rate tunnel, the experiences of the Scandinavian economy may provide a glimpse of what lies ahead for other countries choosing the lesser known side of zero.
Denmark has about $600 billion in pension and investment savings. The people who help oversee those funds say the logic of cheap money fueling investment doesn’t hold once rates drop below zero. That’s because consumers and businesses interpret such extreme policy as a sign of crisis with no predictable outcome.
“Negative rates are counter-productive,” said Kasper Ullegaard, head of fixed-income overseeing more than $15 billion at Sampension in Copenhagen. The policy “makes people save more to protect future purchasing power and even opt for less risky assets because there’s so little transparency on future returns and risks.”
The macro data bear out the theory. The Danish government estimates that investment in the private sector will be equivalent to 16.1 percent of gross domestic product this year, compared with 18.1 percent between 1990 and 2012. Meanwhile, the savings rate in the private sector will reach 26 percent of GDP this year, versus 21.3 percent in the roughly two decades until Danish rates went negative, Finance Ministry estimates show.
The numbers suggest that companies aren’t taking advantage of record-low rates to expand. Dong Energy A/S, a Danish utility preparing for an initial public offering, recently provided a concrete example of this. It is redeeming up to 650 million euros ($745 million) in senior debt in an effort to cut the cost of holding cash, said Allan Boedskov Andersen, head of group treasury and risk management. The decision comes as the company scales back investments in its oil unit.
Denmark’s central bank argues that negative rates have worked because its sole mandate is to keep the krone pegged to the euro in a 2.25 percent band. The currency regime came under attack at the beginning of last year when Switzerland’s failure to defend its euro cap fanned conjecture other central banks would also cave in to speculation.
In the event, the Danes prevailed but only after cutting their benchmark deposit rate to minus 0.75 percent. Sales of Denmark’s AAA-rated government bonds were halted and currency reserves were quickly built up to almost 40 percent of GDP. The measures saved Denmark’s euro peg, allowing central bank Governor Lars Rohde to declare victory.
But while the currency regime was upheld, the macro-economic fallout provides little reason for celebration. There are few signs the extreme monetary stimulus is aiding growth and the government last week slashed its GDP forecast for this year to 1.1 percent, from the 1.9 percent previously seen. March inflation data showed annual prices completely stagnated after about two years of readings well below 1 percent.
And Handelsbanken is warning that the central bank’s battle to defend its euro peg is also not yet over amid signs that policy makers are having to resume currency interventions for the first time in more than a year to weaken the krone.
Carsten Stendevad, the chief executive officer of Danish pension fund ATP, with about $115 billion in assets, says the policy is also proving problematic for markets.
“I’m very concerned about what these low, negative rates mean,” Stendevad said. “I’m concerned about what they mean for asset pricing. Clearly, they are driving asset prices. That’s the intention, but it’s always a cause for concern when asset pricing is driven more by central bank policy than cash flow generation.”
The fund is positioned for a return of inflation, not necessarily imminently, but at some point. Back in February, Stendevad noted that it would be an “anomaly” if very low interest rates didn’t result in “high inflation at some point.”
The only bright spot seems to be the success with which Denmark’s banks have withstood negative rates. Danske Bank A/S, the country’s largest lender, reported its biggest profit on record in 2015. Its first-quarter results exceeded analyst estimates in part as the bank wrote back impaired loans that Danes found easier to repay amid record-low rates.
The bank’s CEO, Thomas Borgen, says Danske is “preparing for these low rates for a prolonged period of time.” Most economists tracking Denmark don’t see a shift into positive rates until 2018 at the earliest.
Danske, like other banks trying to hold on to customers while operating in negative-rate environments, has so far promised retail clients they won’t be asked to absorb the cost of the policy via their deposits.
To make up for lost lending income, Danske and other Nordic banks are focusing more on investing the savings of wealthy Scandinavians in an effort to earn more fees. And with stricter capital requirements making traditional lending more costly, banking in the region may shift more toward wealth administration in the future.
Given the long-term outlook of extremely low rates, Ullegaard at Sampension says the upshot looks clear.
“Eventually, negative rates will have the opposite effect from the intended one,” he said. “They will curb lending rather than pushing borrowing.”