At first glance (indeed, at multiple glances), the concept of a ‘negative interest rate’ seems absurd. Who would want to issue a loan that costs the creditor money? It’s like going to the bank for a home loan, and the bank offering to pay you interest for the privilege of taking its money.
Before you get to carried away with the notion that a bank is about to pay you to build a property empire, it isn’t quite that simple. But the principle is the same here.
Negative interest rates actually aren’t an entirely new phenomenon, although it has accelerated in 2020 due to the coronavirus-induced global recession. We saw negative rates introduced across many countries over the past 10 years, including in Japan, Germany, Switzerland and Denmark. Now, these don’t usually result in banks offering negative interest rates on mortgages. But they do involve the governments of these countries issuing government bonds with a negative interest rate attached.
And now, Australia has reportedly joined this club.
Negative rates for days
According to reporting in the Australian Financial Review (AFR), our Federal Government has just been paid to borrow money for the first time ever. The AFR does note that the government has issued inflation-linked bonds before that came with a negative interest rate. But this week marked the first time that ‘normal’ Australian government bonds have followed suit.
According to the report, the government recently offered a $1.5 billion traunch of 3-month bonds (expiring 26 March). This offer was apparently oversubscribed. One large investor who purchased “at least” $1 million worth did so at a negative interest rate of -0.01%.
What does this mean for the future?
According to a separate report from The Sydney Morning Herald (SMH) last year, ‘unconventional policies’ like negative interest rates are “designed to coerce the banks to behave differently [by] lending and generating economic activity rather than being penalised and losing money by leaving the funds with the central bank”.
It may seem ridiculous to ordinary investors like us for any creditor to accept a negative interest rate. However, the SMH points out that many institutions around the world, such as banks, insurers and some pension funds, have no choice. This is because “their prudential regimes require them to hold a significant proportion of risk-free and low-risk assets”.
This could actually be somewhat beneficial to ASX investors though. The SMH report states that:
There are winners from ultra-low or negative rates. The search for returns in a low-rate environment forces investors into higher-risk assets, such as shares or property… Those without the means, or who were risk-averse, have been punished by the low-rate, low-growth environment since 2008.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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