If you’ve been a good student in our School of Pipsology, you’d know that a country’s interest rate is one of the biggest factors that determine the value of its currency. This is why traders usually keep tabs on central banks’ monetary policy biases, as well as economic data that could influence interest rate expectations.
More often than not, when there’s an interest rate hike or when traders are expecting one, demand for that country’s currency rises and so does its value. On the other hand, when a central bank cuts rates or is expected to do so, demand for their currency drops along with its value. This is because the central bank’s benchmark interest rate dictates the rate of return for holding that country’s assets.
Just this week, ECB officials caused quite a ruckus in the markets by saying that they are considering negative deposit rates. This isn’t the first time that this issue has been brought up, as ECB Governor Draghi talked about negative rates back in June. How in the world is that supposed to work?!
Positive deposit rates mean that local banks get a small return for storing some of their cash reserves with the central bank. By implementing negative deposit rates, a central bank would end up charging banks for keeping cash stored in their vaults. In other words, having negative deposit rates would discourage local banks from keeping more cash lying around instead of lending it out.
Of course changes in deposit rates also tend to have an impact on overall interest rates. You see, when banks can no longer earn returns from keeping cash with the central bank, they are likely to seek gains elsewhere. And with more cash to lend to individuals and businesses, banks won’t mind charging lower loan rates just to encourage more borrowing.
With banks getting smaller profits from lending money out, they could wind up offering lower returns on their investment products and securities. In effect, this would drag down average interest rates in the country, eventually resulting to weaker demand for its assets and currency.
The potential impact isn’t always as straightforward though, as some naysayers argue that local banks could simply pass the cost of negative deposit rates to consumers. If that’s the case, banks would end up charging higher loan rates and therefore discourage borrowing activity. This is probably one of the potential repercussions that FOMC official James Bullard is worried about when he mentioned that the Fed should study the impact of negative deposit rates.
More often than not, when there’s an interest rate hike or when traders are expecting one, demand for that country’s currency rises and so does its value. On the other hand, when a central bank cuts rates or is expected to do so, demand for their currency drops along with its value. This is because the central bank’s benchmark interest rate dictates the rate of return for holding that country’s assets.
Just this week, ECB officials caused quite a ruckus in the markets by saying that they are considering negative deposit rates. This isn’t the first time that this issue has been brought up, as ECB Governor Draghi talked about negative rates back in June. How in the world is that supposed to work?!
Positive deposit rates mean that local banks get a small return for storing some of their cash reserves with the central bank. By implementing negative deposit rates, a central bank would end up charging banks for keeping cash stored in their vaults. In other words, having negative deposit rates would discourage local banks from keeping more cash lying around instead of lending it out.
Of course changes in deposit rates also tend to have an impact on overall interest rates. You see, when banks can no longer earn returns from keeping cash with the central bank, they are likely to seek gains elsewhere. And with more cash to lend to individuals and businesses, banks won’t mind charging lower loan rates just to encourage more borrowing.
With banks getting smaller profits from lending money out, they could wind up offering lower returns on their investment products and securities. In effect, this would drag down average interest rates in the country, eventually resulting to weaker demand for its assets and currency.
The potential impact isn’t always as straightforward though, as some naysayers argue that local banks could simply pass the cost of negative deposit rates to consumers. If that’s the case, banks would end up charging higher loan rates and therefore discourage borrowing activity. This is probably one of the potential repercussions that FOMC official James Bullard is worried about when he mentioned that the Fed should study the impact of negative deposit rates.
Editors’ Picks
EUR/USD flirts with daily highs, retargets 1.1900
EUR/USD regains upside traction, returning to the 1.1880 zone and refocusing its attention to the key 1.1900 barrier. The pair’s slight gains comes against the backdrop of a humble decline in the US Dollar as investors continue to assess the latest US CPI readings and the potential Fed’s rate path.
GBP/USD remains well bid around 1.3650
GBP/USD maintains its upside momentum in place, hovering around daily highs near 1.3650 and setting aside part of the recent three-day drop. Cable’s improved sentiment comes on the back of the Greenback’s irresolute price action, while recent hawkish comments from the BoE’s Pill also collaborate with the uptick.
USD/JPY edges up above 153.50 with all eyes on US CPI figures
USD/JPY appreciates above 153.00 but remains on track for a 2.4% weekly loss. Trading volumes remain subdued on Friday, ahead of the IS CPI release. The Yen remains supported by hopes of a stable government and calls for further BoJ tightening.
Editors’ Picks
EUR/USD: Yes, the US economy is resilient – No, that won’t save the US Dollar Premium
Some impressive US data should have resulted in a much stronger USD. Well, it didn’t happen. The EUR/USD pair closed a third consecutive week little changed, a handful of pips above the 1.1800 mark.
Gold: Metals remain vulnerable to broad market mood Premium
Gold (XAU/USD) started the week on a bullish note and climbed above $5,000 before declining sharply and erasing its weekly gains on Thursday, only to recover heading into the weekend.
GBP/USD: Pound Sterling remains below 1.3700 ahead of UK inflation test Premium
The Pound Sterling (GBP) failed to resist at higher levels against the US Dollar (USD), but buyers held their ground amid a US data-busy blockbuster week.
Bitcoin: BTC bears aren’t done yet
Bitcoin (BTC) price slips below $67,000 at the time of writing on Friday, remaining under pressure and extending losses of nearly 5% so far this week.
US Dollar: Big in Japan Premium
The US Dollar (USD) resumed its yearly downtrend this week, slipping back to two-week troughs just to bounce back a tad in the second half of the week.
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