Negative interest rates and QE: Who is next?


Last Thursday, Sweden’s Riksbank was the latest 16th central bank to act in response to the current currency war this year. It cut its repo rate to -0.1 % for the first time and launched a mini-QE with 10 billion SEK bond purchases. Fears of deflationary spiral, among other factors such as expectations of a weaker euro and slowing growth in Sweden were drawing some serious warnings about its future economic strength and adding to the negative picture of the Nordic country.

Since the first quarter (Q2) of 2014 the Swedish Krone (SEK) has been weakening, losing 35% of its value against the USD and 11% against the EUR.

Chart 1: USD/SEK Monthly

Negative interest rates and QE, USD/ SEK USD/SEK analysis

Low interest rate environment, weak inflation prospects and renewed pressure on governments to keep their exports competitive urged central bankers globally to defend their currencies and boost their economies.

Central Banks in the center of attention

Since the beginning of the financial crisis, central banks have been the dominant focus for markets. After the continuous Quantitative Easing (QE) programs of the Federal Reserve (FED), Bank of England (BOE) and Bank of Japan since 2009, the European Central Bank (ECB) introduced its own QE program this January. The failure to keep inflation in the Euro zone at its target – below but close to 2%, has been putting the ECB president Mario Draghi under pressure. Furthermore, the recent drop of crude oil prices only deteriorated the situation helping deflation to further deepen in January, reaching -0.6% year over year.

Only this year the Danish central bank cut its interest rates 4 times in 3 weeks in an attempt to maintain its peg with the Euro. The bank slashed its key policy rate at -0.75% and intervened in the foreign exchange market with 16 billion USD in order to weaken the krone (DKK).

Why banks use QE and what are its effects?

Central banks have historically boosted economic activity by reducing interest rates, however many of the Western economies have already cut their interest rates to levels close to zero percent, which has meant that they have been given little room for further easing. Quantitative easing is when a central bank buys assets from the market, usually government securities, which increases the money supply by injecting liquidity in the financial markets. This increased money supply aims to facilitate inter-bank lending, as well as lending to businesses and households.

When a central bank purchases securities (mortgage backed securities – MBS, bonds, treasury bills etc) from investors, the latter receives cash in return, which they can reinvest in other more lucrative assets. This means investors are encouraged to migrate some of their capital to higher yielding assets; they are selling bonds in order to reinvest the money in shares. This policy is supposed to have a positive impact on both the stock and bond markets.

Negative interest rates and QE, Central bank & the purchase of securities Central bank & the purchase of securities

First, when the central bank buys a large quantity of bonds, these bonds are removed from the market, pushing up their price. Therefore, they become more expensive to buy and their yields fall. Second, QE tends to lift the market sentiment and stocks become an attractive prospect for yield-hungry investors.

As a result of the diluting effect on fiat currencies, stocks, gold and other commodity prices are expected to increase.

Who is the next one to take action?

Considering the strong trade partnership between Scandinavian countries, we may see Norway to take a similar action soon. With its vast energy resources, which represent around 25% of the overall economy and half of its total exports, the Norwegian Krone (NOK) has been penalized by tumbling oil prices and slower growth expectations. The Nordic currency has depreciated against the USD by 28% since September 2014, reaching a 12 years low, however it remains strong against the SEK.

Chart 2: NOK/SEK

Negative interest rates and QE, NOK/SEK A break above 1.1340 could pave the way for greater bullish movement and jeopardize Norway’s competitiveness

Norges bank governor Olsen assured investors that an unconventional monetary policy is not on the table and if eventually the bank intervenes, it will be using standard measures such as interest rates and nothing else. Even though the Nordic country keeps inflation close to its 2.5% target (2.4% currently), slowing growth in its main trade partners (Sweden and Northern Europe), combined with falling oil prices may drag consumer prices down putting further pressure on Norges bank to lower interest rates in the first half of 2015.

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