Swiss negativity, free lunches and the IMF Everyone has an open mind about negative rates these days... Swiss National Bank chief Thomas Jordan has said he certainly does following this piece of repeat advice from the International Monetary Fund's annual report on Switzerland (our emphasis): The conjuncture of Switzerland may render some of the potential drawbacks [of negative interest rate] less relevant than in other countries. Activity in the interbank market is already very low, as all banks have excess liquidity. Switzerland is experiencing strong credit growth, particularly in the mortgage market. The impact of negative interest rates on mortgage rates depends on the pass-through. If banks cannot pass through negative rates to depositors, then negative interest rates on bank reserves would induce banks to increase mortgage interest rates; this would help curbing the growth of mortgage lending and housing prices. In this case, negative interest rates could help address the dilemma the SNB faces: low interest rates are necessary to defend the floor while fuelling the bubble in the housing and mortgage markets. It would also alleviate the central bank's pressure from expanding further its balance sheet. On the other hand, corporate loans may also become more expensive, possibly reducing already weak investment. If banks can pass through negative rates to depositors, then lending rates would decline and pressures in the mortgage markets may intensify, but the pressures may be tempered if negative interest rates reduce capital inflows. The Fund's point is that the Swiss National Bank should keep its floor of SFr1.20 against the euro as Switzerland is still experiencing deflation and if things go belly-up globally it will face renewed safe haven flows. Not many people think the SNB will start fiddling with the floor as, for one, raising it might be politically tricky - overtly going for the exchange rate isn't too popular. So if safe haven inflows return, the SNB might well consider imposing a negative interest rate on bank excess reserves. The aim would be to dissuade inflows while cooling the frothy property market. The SNB has said before that it is worried that excessive monetary easing will stoke bubbles. A negative rate policy might be a neat way to step in. Denmark's experience does suggest that one can fiddle with an exchange rate via negative interest rates if you are a closed, essentially fixed rate economy, looking to force outflows or dissuade inflows - as Valentin Marinov at Citi said, "the Danish Crown sold off in response to similar measures introduced by the Danish CB last year" Deutsche recently suggested that tech problems, repo markets and difficulties passing on costs to end customers might be where the unintended consequences of negativity hit banks. But, as Deutsche also note, "the repo market has proved its ability to handle negative interest rates for a while in CHF" while Swiss banks had really better be prepared for this by now and as Simon wrote before "banks are considerably less likely to change their lending and deposit rates post financial crisis." From the IMF again: Negative rates are present in some market segments in Switzerland. The Swiss government bill rates and some bond yields have already been negative for some time. In December2 012, Credit Suisse and UBS imposed negative interest rates on large short-term institutional deposits in Swiss francs. Both banks indicated that this was to manage their balance sheet in response to regulatory requirements. Market reactions on the foreign exchange and money markets on the day of announcements were significant. In addition, the measures resulted in a rapid drawdown of the affected deposits, suggesting that negative interest rates can be effective. The recent experience with negative interest rates in Denmark has been favorable so far. Facing safe haven flows from the intensification of the euro zone crisis in the summer of 2012, the central bank of Denmark cut the rate on certificates of deposits (CDs) to -0.2 percent on July 5, 2012. The reduction of the CD rate below zero was accompanied by a simultaneous increase in the amount of reserves that banks could hold in their accounts at the central bank (their "current accounts") at a zero interest rate to limit the amount of reserves subject to the negative rate. In the aggregate, banks can hold up to DKK 69.7bn (up from DKK 23.15bn) in their accounts at the central bank, while they receive a negative interest rate on any cash balances at the central bank in excess of this limit. After the move to the negative rate, money market rates fell, deposit rates did not change, and lending rates dropped slightly. The move achieved the desired impact on the exchange rate by reducing money markets rates and capital inflows while adverse repercussions on liquidity and the pass-through to credit conditions and retail customers were either short-lived or minimal. This chart from UBS's Syed Mansoor Mohi-uddin shows that while rates on new Danish mortgages have not gone up, they appear to have stopped falling which suggests a pretty benign impact: But, as with all negative interest rates threats it's very hard to separate the bluff from the reality. Why wouldn't Jordan and the SNB push this a bit to scare the franc a bit weaker? It certainly dived against the euro as all of this was discussed. That's not to say the SNB won't move though - it's not exactly predictable and analysts we talk to definitely don't rule it out - it's just that nothing we have heard so far seems like very much of a guide. Related links: Happy birthday Swiss franc floor: we salute you - FT Alphaville Switzerland imposes capital buffer on banks - FT How Low Can You Go?