Deutsche Bank Thinks Central Banks Can Still Cut Rates: Here's How

• The idea of a zero lower bound for interest rates in the U.S. and other major global economies may soon be tested.
• Several major central banks have already implemented sub-zero interest rates.
• The policies have not led to a significant spike in currency circulation and could serve as a favorable option compared to QE.

Deutsche Bank analyst Abhishek Singhania believes that there is no such thing as a zero lower bound when it comes to U.S. interest rates. In a new report, he discusses five reasons why sub-zero interest rates seem feasible and could prove to be the best stimulus tool in the future.

Precedent set
The first argument that negative rates would work is the fact that several central banks, including the ECB, SNB, the Riksbank and Denmark’s Nationalbank, have already dipped their toes into negative-rate policy. Despite fears to the contrary, there has been no evidence of an increase in cash circulation in any of these regions.

The evidence
Singhania lists five reasons why negative interest rates could work:
1. So far, banks have not passed on negative rates to retail and corporate depositors.
2. The direct costs of negative rates are low enough for banks to manage them.
3. Banks have chosen to pass on some of the costs to borrowers via higher mortgage rates.
4. What ultimately matters for bank profitability is the slope of the rate curve, not the absolute level of rates.
5. There could be regulatory solutions, such as cash withdrawal limits, if withdrawal runs begin to materialize.

Negative rates versus QE
The ultimate decision, should the need for economic stimulus arise in zero-rate economies, would be the choice between negative rates and further QE.

“For the ECB, the disadvantages of negative rates relative to QE are the need to ease financial conditions for the economy as well as the fragmentation of money markets meaning deeper negative rates may be more difficult to implement,” Singhania explains. He adds that negative rates are a more attractive option for the ECB at the present time than they were a year ago.