This week the markets have reacted to increased speculation surrounding negative borrowing rates imposed by central banks. Currently the Swedish Riksbank (-0.5%), the Bank of Japan (-0.1%) and the ECB (-0.3%) are the most prominent central banks imposing negative rates.
Despite purchasing huge amounts of government debt through QE, inflation remains below policymakers’ targets. These pressures on inflation, and worries over the possibility of deflation, have led to central banks taking action in an effort to stimulate growth and inflation. By imposing negative rates, a central bank hopes to a) weaken its currency, thus bolstering its economy’s competitiveness internationally, and b) promote lending from banks, which naturally want to avoid paying a fee for holding excess funds with it.
Central banks are entering unchartered territory and investors are finding it difficult to model the impact of such policies and any unanticipated side-effects. Banks have not yet passed on the costs incurred from negative rates to customers and so are having their margins squeezed. In response, they are likely to chase riskier loan business so as to protect their margins. However, the fear that central banks will enter into ‘currency wars’ and race each other to ever lower interest rates is clearly a concern for the sector.
So why would anyone want to own shares in a bank? First, the sector is perhaps unique in being valued at half its pre-crisis level with half the leverage. Second, the importance of bank lending growth for the wider economy is well understood. Third, the regulatory and litigation headwinds from the likes of PPI may well be close to a nadir. As always, investors must consider whether valuations are attractive relative to prospects.
______________________________