Central banks expanded their policy toolbox since the 2008-2009 Great Financial Crisis. Besides conventional monetary policy tools (i.e., change the policy rate to influence inflation), unconventional tools are now the norm. Quantitative easing, forward guidance, TLTROs – are just a few new tools used with various degrees of success all over the developed world.
One of the monetary policy “limitations” up to the 2008 crisis was the lower boundary. More precisely, major central banks did not lower the official rate below the zero level. However, shortly after the financial crisis, some of them did (i.e., the ECB, SNB, Riksbank).
At this point, keeping the interest rate below zero became normal. The big question moving forward is, for how long will we see lower interest rates? According to a recent study by Robeco, negative rates are here to stay for quite a while.
Will the Fed Go Negative Too?
Robeco used various scenarios for both the ECB and the Fed in its projections for the future level of interest rate. As the two are the most important central banks in the world, it is worth considering the outcome.
For the ECB, only one scenario out of four predicts that the ECB rate will rise above zero. Moreover, in that “optimistic” case, it will do so only in 2025. The other three scenarios see the ECB holding the deposit facility rate below zero. Also, in an extreme case, it even sees the ECB lowering the rate to -1% from the current -0.5%.
The Fed always argued that it does not consider lowering the federal funds rate below zero. It says that it is inconsistent with the Fed system and does not see many benefits of such a move. However, in monetary policy, just like in politics, traders should learn to never say never. Robeco sees the Fed’s federal fund rate much higher in five years when compared to the ECB.
Both central banks target price stability. On top of that, the Fed targets maximum employment too. However, the Fed shifted its mandate recently, as signaled at this year’s Jackson Hole symposium. Nowadays, the Fed targets average inflation around 2%, while the ECB settles for inflation below, but close to 2%.
However out of the two central banks only the Fed managed to bring inflation close to 2% recently (i.e., in 2018). The ECB failed consistently. Therefore, with inflation falling on both sides of the Atlantic, investors should not be surprised to see negative rates remaining low for an extended period of time.