The march to negative interest

Declining rates
Angus McCrone By Angus McCrone, CA magazine

16 November 2016

Angus McCrone examines the implications of the topsy-turvy world of below-zero interest rates.

Quarter of a century ago, business titans of the time such as Lord Weinstock of GEC and Lord Hanson of Hanson Trust maintained corporate cash piles of hundreds of millions of pounds, and viewed interest on those deposits as a key part of group profits.

Those two industrialists, if brought back to life today, would scratch their heads at the current era, when company liquidity earns almost nothing, pension fund deficits are going through the roof because actuarial discount rates have collapsed, and some central banks are toying with pushing interest rates deeper and deeper into negative territory.

If the idea of investors paying to lend to companies sounds absurd, then what about government borrowing rates? 

In places, an alien world has started to emerge. In September, French pharmaceutical company Sanofi and German household goods firm Henkel issued bonds at negative interest rates. For Sanofi, it was €1bn of three-year bonds at minus 0.05 per cent; for Henkel, it was €500m of two-year notes at the same yield.

If the idea of investors paying to lend to companies sounds absurd, then what about government borrowing rates? In late September, the yield available on two-year Swiss notes stood at minus 0.9 per cent, while 12 other countries also sported negative yields at that duration.

Making savings even less attractive

In Britain, by this autumn, things had not got quite so extreme. Not quite – although Bank of England interest rates were cut to 0.25 per cent in August, and ultra, ultra-loose monetary conditions fuelled £11bn of sterling-denominated corporate bond sales in July to September, by companies such as Vodafone, BP and Toyota. National Grid issued £3bn worth of bonds in mid-September, the coupon on its five-year issue at only 1.125 per cent.

There are two possible views about the march deeper and deeper towards, and into, negative interest rates. One is the prevailing central bank one – that if economic growth fails to fire properly when interest rates are unprecedentedly low, then the only way to get consumers spending and companies putting money into capital investment is to deter them from saving by putting a minus sign in front of deposit rates. And if that does not immediately work, go lower.

The other view is that this will be seen in the future as the economics of the madhouse.

In Europe, the policy regime has started to undermine confidence in the banks.

What is clear is that, so far, record-low interest rates have not produced vibrant economic growth anywhere. Japan, one of the prime test cases, is still locked in deflation and its currency has been on the way up, not the way down as policymakers had intended. In Europe, the policy regime has started to undermine confidence in the banks, because their margins are being squeezed.

In the UK, the Bank of England’s August inflation report said: “Business investment fell in 2016 Q1, and is projected to continue to fall in the near term.” Now, the Bank might say that things would be even worse if interest rates were higher. And it might also say that uncertainty caused by the 23 June Brexit referendum has overwhelmed the beneficial effects of low interest rates.

Will companies start hoarding cash?

But what if this sort of view remains the accepted wisdom, and rates go lower and lower – into the negative zone? What might happen to corporate finance? At a simple level, companies would earn interest from their borrowings, and pay interest on cash deposited.

Instead of it making sense to gear up a balance sheet to offset interest charges against taxable profits, gearing up would actually raise profits but add to the tax bill. Companies with net cash on the balance sheet would earn nothing on that, although they could offset the interest charge on those deposits against taxable earnings. Since cash carries a cost, accounts departments might even be told to seek late payment of invoices by debtors, not to seek early payment.

On the plus side, from the point of view of policymakers, any investment offering a positive return (no matter how low) ought to make economic sense to a business, although they could instead just opt to distribute all – or even more than all – post-tax profits to their shareholders. Of course, there is another possibility: that companies, like private citizens, would resort to holding cash in vaults and safes in order to avoid interest charges. German insurer Munich Re has already put €10m of its cash into vaults, and safe manufacturers in Japan are reporting bumper sales.

In the words of Mr Spock, for companies, it really would be “life, Jim, but not as we know it”.

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