Negative Interest Rates Are Bad News for Canadian Dollar
Weak oil prices have hammered the Canadian dollar, sending the CAD to USD exchange rate to an 11-year low, but this might only be the beginning.
On Tuesday, the Bank of Canada (BoC) announced it would be willing to cut the benchmark interest rate to below zero percent if the country’s economy continues to deteriorate. During a speech in Toronto, the central bank’s governor, Stephen Poloz, described negative interest rates as one of four “unconventional monetary policy measures” the bank would be willing to implement if the country is faced with a major economic shock.
“We don’t need unconventional policies now, and we don’t expect to use them,” Poloz said. “However, it’s prudent to be prepared for every eventuality. […] What we’re saying today is that we now believe that we have roughly a hundred basis points’ worth of room to manoeuvre underneath our current interest setting. […] All these things would be on the table in the face of a significant shock.” (Source: “Bank of Canada willing to resort to below-zero interest rate in face of major economic crisis, Poloz says,” National Post, December 8, 2015.)
Such a move could have enormous consequences for both households and the Canadian economy.
First, banks would have to pay a fee when they deposit money with the BoC. In theory, this would encourage them to lend out reserves, stimulating the economy. This could also hammer savers, whereby bank depositors would actually be charged interest when they deposit money in a bank.
Second, negative interest rates could also devastate the value of the Canadian dollar. Investors scour the world searching for the best return on their money, but in a negative rate scenario, hot money managers would be tempted to sell their Canadian holdings in favor of greener pastures elsewhere.
The BoC has slashed its benchmark lending rate twice this year in an attempt to stimulate the economy. So far, Poloz hasn’t resorted to negative interest rates. However, other countries, including Switzerland, Sweden, Denmark, and the European Central Bank, have all dipped their benchmark rates below zero.
Poloz emphasized he has no intention to immediately bring in negative interest rates and the central bank was only investigating these measures. But Canadian dollar spectators should be watching the BoC closely. If the Canadian economy continues to worsen and Poloz slashes interest rates below zero, fleeing investors could send the CAD to USD exchange rate plummeting further.