In an article titled An Ugly Deleveraging, Pimco managing director Andrew Bosomworth said European governments are failing to address “growth’s secular headwinds” with structural reform, instead focusing on monetary policy.
Mr Bosomworth said the benefits of lower negative rates are declining while the costs are rising.
Reducing interest rates further is “counterproductive”, said Mr Bosomworth.
Financial stability, he said, is threatened as a result of further rate cuts. Namely, negative rates reduce banks’ profitability due to the lowering of net interest income.
“Negative interest rates force banks to cut costs, raise revenues or find other ways to remain viable,” he said.
“One way is to raise interest rates on loans and mortgages. Paradoxically, negative interest rates might lead to higher borrowing costs for consumers and businesses.”
He pointed out that Sweden’s Riksbank and the Swiss National Bank cut their policy rates to -0.5 per cent and -0.75 per cent respectively. However, banks in these countries increased mortgage lending rates relative to the policy rate to improve their profitability.
“By not passing negative interest rates on to retail customers, banks shelter households’ savings and consumption behaviour from the incentives of paying to save.”
Mr Bosomworth said that with the eurozone's interest rate on its deposit facility at -0.4 per cent, the European Central Bank has “effectively exhausted interest rate policy”.
The implications for investors are that eurozone growth and inflation will remain low.
“To achieve their return targets, investors may have to make structurally larger allocations to higher-yielding corporate and emerging market bonds,” Mr Bosomworth said.
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