(The opinions expressed here are those of the author, a columnist for Reuters.)
By James Saft
Dec 1 (Reuters) - Switzerland's experience of negative interest rates should give the European Central Bank pause.
The ECB is widely expected to cut rates when it meets on Thursday, taking rates, already at -0.20 percent, another 10 or 20 basis points further into the negative and expanding or extending its campaign of asset purchases.
While the threat of deflation in the euro zone is real, negative rates impose hard-to-mitigate costs, especially on the banking system. Like much medicine, low rates have perverse effects at extreme levels.
Switzerland in January took rates to -0.75 percent, and on the evidence, there has been only partial pass-through of lower rates, particularly to mortgage borrowers.
The thinking behind negative interest rates is based on the belief that as official rates fall, so will those in the market, making it cheaper and easier to buy, consume, build and invest. Yet negative interest rates punish the banking system, a particularly crucial and vulnerable part of the euro zone economy, and potentially undermine the expected impact of cheaper official money and create unwanted side-effects.
"This is a case of basing policy on models which assume what they need to prove," writes Eric Lonergan, a macro hedge fund manager and economist. (http://www.philosophyofmoney.net/negative-interest-rates-dont-work/) "The initial findings suggest that we should indeed be very careful about expecting our models to work as assumed."
The interest rates on government bonds in Switzerland have plunged in reaction to official policy, with 10-year bonds yielding a record low -0.41 percent. But there is a disconnect between securities markets, over which central banks have much control, and private lending, which still requires that banks can turn an acceptable profit in order to function.
Andréa Maechler, a member of the governing board at the Swiss National Bank, noted in a Nov. 19 speech that long-term mortgage rates in Switzerland are actually higher than they were at the beginning of the year, before rates were cut.
"This is because banks' refinancing costs have not fallen to the same extent as money market interest rates," Maechler said. "As a result, banks' interest margins have come under pressure, and to partially offset this effect, banks have raised their mortgage interest rates."
WHO BENEFITS?
Negative rates do not, at least to judge by the markets' reaction, make banks a better credit to those who provide them with capital. Or, at least we can say that the market view of the risk of lending to banks has not in Switzerland moved lower as briskly as have money markets.