Pimco jumps on the bandwagon against negative rates

Bond powerhouse Pacific Investment Management Co (Pimco) has become the latest high-profile critic of negative interest rates, warning that one of the key central bank tools in economically beleaguered Europe and Japan may do more harm than good.

In a report published on Tuesday, Pimco noted three key drawbacks of sub-zero rates. They squeeze the profitability of banks and, thus, might actually reduce lending; they depress market returns and create significant challenges for pension funds and insurers that offer guaranteed payouts; and they create a money illusion in which savers feel poorer and, thus, cut consumption.

While those criticisms have long been levelled at institutions such as the European Central Bank and Bank of Japan, the voice of Pimco – with $1.9 trillion of assets under management – adds to a rising clamour. Goldman Sachs CEO David Solomon called them a failed experiment, and even central bankers have started expressing concerns about the side effects.

The unintended consequences of negative interest rate policy are already evident, portfolio managers Nicola Mai and Peder Beck-Friis wrote. It does not have much further room to run.

Economic theory suggests that cutting interest rates below zero should have a similar expansionary effect to reducing them in a positive-rate environment. It should incentivise people to save less and spend more, boosting growth and inflation.

In practice, the researchers found that while sub-zero rates initially helped ease financial conditions and boost lending, especially in the euro area, that impact has been spent. The ECB is one of just five central banks with such a policy, along with those of Switzerland, Sweden, Denmark and Japan.

Trouble brewing

Pimco said significant trouble is brewing under the surface at banks, which must pay to central bank to hold reserves but can’t easily pass the cost on to customers. Deutsche Bank President Karl von Rohr said last month that the region’s banks and insurers have lost dramatic amounts of ground to competitors, with only one still ranking in the top 20 globally by market value, compared with six before the global financial crisis.

In Japan, where the policy rate is minus 0.1 per cent, Governor Haruhiko Kuroda is finding it increasingly hard to get support from the country’s Shinkin regional cooperative banks, which rely heavily on deposits for funding.

In an attempt to boost their returns, investors are chasing riskier assets that might prove to be harder to sell. That is a particular worry for pension funds, which are often required by law to guarantee a certain level of payments to retirees. Pimco warned of instability and potential capital injections if they fail to deliver.

Finland’s Ilmarinen Mutual Pension Insurance Co, with $55 billion in assets, says it is buying fewer easy-to-sell assets, a sign that liquidity has become a luxury of a bygone age.

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