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Negative interest rates aren't likely in Canada, but here's what that would look like, anyway

Cameron French

The Bank of Japan recently shocked global financial markets once again last week with its decision not to pay out any more monetary stimulus for its struggling economy. But that’s hardly the most stunning decision it’s made this year.

In February, Japan made the controversial move to adopt negative interest rates for the first time ever, in the hopes of shocking its sluggish economy into action. Negative rates have also been adopted by some European countries, as well as the European Central Bank.

Why should we care here in Canada? Well, the Bank of Canada said in December that Canada could also adopt negative interest rates if the nation faces an economic crisis. It’s never happened here, and it may be a long shot, but here’s a primer on what negative rates would mean.

What are negative interest rates?

Think of a loan that works in reverse: instead of you paying interest to borrow the money, the bank pays you to borrow. So if you borrow $1,000 at a 1 per cent interest rate, you owe $10 a year in interest. But if rates go to -1 percent, theoretically you would borrow the $1,000 and get $10 a year on top of that. Of course, with a savings account where you earn interest, the effect would the opposite. So you’d be paying the bank to hold your money.

Now, even if we do go to negative rates, the above examples probably won’t come to pass, because the savings will likely get sucked up by the big banks and won’t trickle down to the consumer (read: you). But that’s the general idea.

How they work

The Bank of Canada (BoC), Canada’s central bank, lends money on a daily basis to the country’s big banks, which gives them a lot more business flexibility. The rate that the BoC charges the banks determines how much the banks are paying to borrow money, and so also influences the rates the big banks charge customers for mortgages and other loans, or pay customers in their savings accounts (that tiny return you get for doing nothing). In other words, when the BoC cuts its rate, the big banks usually cut their rates. Currently, the BoC’s key lending rate is 0.5 per cent, which is the lowest it’s ever been. Bank mortgage rates are higher, because the banks add in a cushion so they can make a profit.

What is the benefit?

The general idea is that low interest rates prompt people and businesses to borrow and spend money, which stimulates economic growth. That’s why the BoC cut rates sharply in the wake of the 2008 financial crisis and has been keeping them at rock-bottom levels since then. Negative rates would encourage the banks to put their money to work, and would give consumers access to even cheaper debt.

“It gives businesses and investors the ultimate reason to go out and invest, because parking it at the central bank you essentially have to pay a premium,” says TD economist Leslie Preston.

What are the risks?

Aside from the premise that adopting a negative interest rate will only happen if our economy goes into full-blown crisis mode, there are additional risks.

“Obviously the currency would come under pretty significant downward pressure if the central bank moved to negative interest rates,” says BMO economist Sal Guatieri.

That’s because a low rate means Canadian investments return less, which drives investors to other currencies. Another problem is that the entire premise of negative rates is to encourage more borrowing at a time when Canadian household debt is already at all-time highs.

“The risk is you’re creating imbalances that could ultimately do the opposite of what you’re intending to do and pull the economy down,” says Guatieri.

How would it affect you?

Apart from the aforementioned economic risks, a move to negative rates likely wouldn’t be any more noticeable to the average consumer than a typical central bank rate cut. While lending and mortgage rates would fall, they wouldn’t actually hit the point where the banks are paying you to borrow, since bank rates are higher than central bank rates. And it’s unlikely the banks would actually charge customers interest to hold their money in savings accounts. “The problem is many customers would balk at seeing a negative rate,” says Guatieri. Instead, the banks might hike fees to make up the difference.

Will it happen?

While many economists expect the Bank of Canada cut rates again before the end of the year, negative rates aren’t likely. Growth has been sluggish, but economists say we’re still in better shape than Japan and Europe.

“We do expect the Canadian economy to grow over the coming quarters, but the bank needs to be prepared if an unanticipated shock hits,” says Preston.

She says the odds are not zero, so it’s something to be aware of. But don’t start counting up the potential savings on your mortgage payments just yet.