Negative Interest Rates: How will it affect the Gold Price?
Negative Interest Rates: How will they affect the Gold Price?
Negative Interest rates are now commonplace; just the wording makes me suspicious. The word negative never makes one feel comfortable. Is this the right policy, what are Negative Interest Rates and should we be worried?
Yesterday was the latest announcement from the European Central Bank (ECB), which outlined a further cut to negative interest rate territory. The fixed rate lending has been cut from 0.05% to 0% and the deposit facility, used by the banks for holding money overnight with the central bank, has been cut from -0.3% to -0.4%.
What are Negative Interest Rates?
In effect negative interest rates mean that the banks are being charged to hold money on deposit. In times of deflation, businesses and banks tend to stockpile cash for the leaner times, by invoking a negative interest rate, the logic is that the banks are going to want to lower their positions on cash being held dormant, as it is now costing them to hold it. A negative interest rate therefore looks to incentivise the banking industry into offloading some of their deposits through lending – this will of course help to stimulate the economy and the all-important inflation numbers (which in the last year for the ECB have been woeful).
That is the dream scenario of course, whether that will be reality we will have to wait and see.
How will Negative Interest Rates affect the Gold Price?
In answering this, I think you firstly have to look at currencies. What is likely to happen in the mid to long term? After the ECB announcement yesterday, the Euro rather surprisingly strengthened against the dollar. This I would imagine is the investors’ response in support of Mario Draghi trying to boost the Eurozone. Realistically however, the last cut of -0.3% hasn’t done the trick so by increasing it -0.4% will it make any difference? My guess would be that the banks will accept the deeper cut, sure it means they have spent a little more but presumably they decided keeping the cash in the bank was safer than lending it out despite having to pay for the privilege. I think there is certainly the argument that even if the negative rates are punitive on banks, at the moment they aren’t lending as they can’t see the profitability in doing so, which actually speaks volumes about the kind of mess the global economy actually is in.
So with that in mind, gold is probably going to fall mercy to an increasing dollar but ultimately I think the message of negative interest rates is going to knock investor confidence in the mid to long term. Gold may sit slightly lower whilst the dollar creeps up but it is no surprise to me that central banks are beginning to stockpile the yellow metal as of 2015. China and Russia have been most active in buying gold which makes me think that they are aware of further economic problems ahead. I’m still keeping my eyes and ears open as I’m convinced there is more unsettling news to come from China.
Verdict:- Negative Interest Rates are in truth are a bit of a stab in the dark. I look at the banks being charged like I would buying a plane ticket on a budget airline. The airline offers a business class seat, which basically means you have fractionally more legroom. We are all going to get to the same destination yet some people feel the need to pay double or triple the normal fare to have something only fractionally better. Why? The extra cost is irrelevant. It means nothing to them because they would rather have the knowledge that they are having a marginally better journey than the other chumps at the back of the plane. Banks no doubt feel the same. Yes they are being charged to have their money safe, yes it seems ludicrous to accept the charge but it isn’t going to incentivise them to shift it. They would rather have the knowledge that it is probably better to hold it with the central bank than lend it out. It is less costly and it is less risky. Much like our the global economy, “Flying is hours of boredom, punctuated by moments of stark terror” – I think investors are in for some turbulence.
Article by Michael Cooper