Negative interest rates: The new weapon in the forex wars

February 4, 2015 09:53 AM

Quantitative easing has been around some seven years in its current form, but now another monetary policy tool is gaining momentum called negative interest rates. This is likely to become a weapon of choice in the currency wars and a key driver of exchange rates.

Since the crude oil price plunge late last year (though it has bounced recently) a flurry of interest rate cuts have been triggered around the world with two countries opting for negative interest rates -- Switzerland (-0.75%) and Denmark (-0.2%). Both countries are hoping to drive away capital inflows by charging investors for holding their currencies as opposed to creating more money as happens with QE.

Both are responding to the fierce devaluation policies being pursued in the Eurozone by the European Central Bank (ECB deposit rate -0.2%). These policies are being pursued to manipulate exchange rates. Both are trying to preserve their export competitiveness with Denmark battling to maintain DKK's exchange rate band with the EUR. 

Should the euro keep falling, Denmark is likely to go deeper into negative interest rate territory and possibly even move its trading band with the EUR upwards, which would involve negotiations with the Eurozone as it is in the European Exchange Rate Mechanism (ERM). 

Another domino resulting from the ECB's monetary policy could eventually see Sweden's Riksbank also go into negative interest rate territory to put downward pressure on SEK. Its repo rate is currently zero. In the UK, providing the real estate market doesn't overheat, it could see the Bank of England delay its much mooted interest rate rise well into 2016.

For now, worries about the Eurozone and political uncertainty ahead of the May general election are working their magic in keeping GBP relatively weak – though it has been gaining against the euro.

EUR/SEK: Could Sweden be the next European country to go negative on interest rates?

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About the Author

Justin Pugsley is the forex and gold markets analyst for New Zealand-based trading platform provider MahiFX. He is a keen student of markets, economics and history. Prior to working with MahiFX, Justin worked for a number of leading media organisations such as Thomson-Reuters and Dow Jones/Wall Street Journal.