Investment Management

Coursework 2 - Essay

Edinburgh Napier Number: 40271739

Submission Date: 22nd October 2020

Word Count: 1,050

ACC10102 EDINBURGH NAPIER NUMBER: 40271739

Table of Contents
Table of Contents 1

Introduction 2

The Significance for Investment Management 3

Literature Review 5

Lessons from the Swedish Experience with Negative Central Bank Rates - Fredrik N.G.
Andersson and Lars Jonung 5

Negative Interest Rate Policy in Switzerland - Elisabeth Ziegler-Hasiba and Ernesto Turnes 5

An Impact Assessment of Negative Interest Rates of Central Banks - Linas Jurkšas 6

Conclusion and Further Research 7

References 8

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Introduction
After a period of already low interest rates from the aftermath of 2008 financial crisis,
Coronavirus pandemic has further shot down the Bank of England interest rate to 0.25% on
11th March and to 0.10% on 19th March 2020 (Bank of England, 2020).

Financial Times’ (2020) article ‘BoE asks banks how ready they are for negative rates’
reports that Bank of England is now considering what impact would zero or negative bank
rate have on banks’ operations. Although Andrew Bailey, the Bank of England governor,
made it clear that the rate would not go negative in the near future (Financial Times, 2020),
the banks must reply by 12th November whether and how they would cope.

Bank of England and Prudential Regulation Authority will then have to consider the
implications of negative rates on financial stability, safety and soundness of firms and the
effect on the wider economy (Financial Times, 2020). With the expectations of further
increase to the Bank of England’s bond-buying programme (Financial Times, 2020),
investors will have to consider how to adjust their portfolios to the latest news.

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The Significance for Investment Management

Tokic (2016) highlights that about one-third of global economy had already implemented
negative rates, so the Bank of England would only be following the trend. Investors will
therefore have to consider moving away from the usual safe-haven investment grade bonds to
earn a return.

One of the options is to move into commodities such as gold. When even Warren Buffet, long
time critic of investing in gold, started buying shares of gold miner Barrick Gold (Arora,
2020), this will be a signal to other investors and as seen in Figure 1, the market has already
started moving up.

Figure 1 - Gold Price (6 month) (Trading Economics, 2020)

Duncan (2020) suggests that investors will be looking to invest overseas in order to diversify
their portfolios away from the potential exposure to a decline in the value of Sterling. Figure
2 shows the statement of the Bank of England exploring negative rates resulted in 0.6% drop
in value of Sterling against the Dollar (Szalay, 2020).

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Figure 2 - Sterling against the Dollar - 17th Sep 2020 (Szalay, 2020)

Another option for investors is to look to invest in companies that are likely to generate
profits even in this challenging climate. Lower interest rates mean lower discount rates, so
the present value of future earnings increases for UK companies and this tends to push the
share price up (Schroders, 2020).

These are just few options the investment managers have to explore but with Coronavirus
pandemic affecting all sectors of economy, no-deal Brexit looming large, the negative interest
rates only add to the complexity of investment planning.

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Literature Review
Lessons from the Swedish Experience with Negative Central Bank Rates - Fredrik N.G.
Andersson and Lars Jonung

Andersson & Jonung (2020) analysed Sweden’s experiment with negative central bank rates
and argue the costs to Swedish society most likely exceeded the benefits. Sweden first used
negative rates in 2009 as a result of financial crisis, but next time it was in 2015 for almost 5
years during a time of relative prosperity to address low inflation (Andersson & Jonung,
2020). Authors found that the negative rates highly affected the real estate market and pushed
the prices and household debt levels to record levels (Andersson & Jonung, 2020). This study
is important to investment management as it makes the connection between negative rates
and their impact on bigger economies. Andersson & Jonung (2020) suggest that the impact on
bigger economy would be as big or even bigger than in Sweden and this would result namely
in property prices rising and depreciation of the currency. Devalued currency tends to push
investors to foreign stocks as they become more attractive.

Negative Interest Rate Policy in Switzerland - Elisabeth Ziegler-Hasiba and Ernesto

Turnes

Ziegler-Hasiba & Turnes (2018) reviewed the negative interest rate policy of the Swiss
National Bank and its implications for the economy and financial markets. Switzerland
implemented negative interest rate policy in 2015 aiming to boost inflation and combat the
appreciation of the Swiss Franc (Ziegler-Hasiba & Turnes, 2018). Authors found that lower
interest rates increase the asset and real estate prices, which both increase household wealth
and incentivise further asset purchases driving up the prices (Ziegler-Hasiba & Turnes, 2018).
Ziegler-Hasiba & Turnes (2018) particularly highlight the impact of negative rates on
investors such as pension funds which are legally obliged to hold certain amount of low-risk
assets and to guarantee promised minimum yields, they are driven to riskier assets. This study
will interest UK investors as it emphasises the impact of interest rate policy on the investment
decisions and draws attention to declining government bond yields which drive investors to
riskier assets, pushing prices of these assets up and potentially creating a bubble.

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An Impact Assessment of Negative Interest Rates of Central Banks - Linas Jurkšas

Jurkšas (2017) looked at motivation behind introduction of negative interest rates and the
impact they have on different economic sectors. Apart from Sweden and Switzerland, author
also considers Japan, Denmark and European Central Bank who all adopted negative interest
rates. Notably, European Central Bank’s motivation was to address low inflation, weak
recovery and excessive risk aversion (Jurkšas, 2017). Jurkšas (2017) highlights theory that
lowering the interest rates is meant to induce firms and households to bring forward
consumption and investment decisions. This study stresses that pension funds and life-
insurance companies have to increase their share of higher yielding, riskier assets (Jurkšas,
2017). Jurkšas (2017) concludes that if negative interest rates are kept for too long, they may
lead to overvalued asset prices potentially causing economic downturn should the policy get
reversed and investors pulled their money back. And this would inevitably damage the
investors who are left holding the assets with their price plummeting.

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Conclusion and Further Research

Negative interest rates are not a new concept (Tokic, 2016) but have never been implemented
by the Bank of England. However, with calamitous impact of the Coronavirus pandemic and
no-deal Brexit looming, further reducing the 0.10% interest rate seems inevitable to aid
economic recovery in the UK.

With institutional investors looking beyond bonds to secure a fixed income and avoid
watching their deposits shrink, an empirical study into hedging against negative rates is
needed. Previous studies have all focused on the countries that have implemented negative
interest rates and evaluated their effectiveness for the economy as a whole. The new study
should focus on analysing the strategies deployed by the investors in these countries to
combat the negative rates. This study would provide invaluable insight for the UK investors
trying to move towards a diversified portfolio that can profit should the Bank of England
follow suit of other central banks.

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References
Andersson, F. N. G., & Jonung, L. (2020). LESSONS FROM THE SWEDISH
EXPERIENCE WITH NEGATIVE CENTRAL BANK RATES. Cato Journal, 40(3),
595-612. doi:http://dx.doi.org.ezproxy.napier.ac.uk/10.36009/CJ.40.3.2

Arora, N. (2020). Warren Buffett undergoes a conversion on gold — should you follow him?.
Retrieved from https://www.marketwatch.com/story/warren-buffett-undergoes-a-
conversion-on-gold-should-you-follow-him-2020-08-17

Bank of England. (2020). Interest rates and Bank Rate. Retrieved from https://
www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate

Duncan, E. (2020). Three asset classes to protect portfolios against negative interest rates.
Retrieved from https://www.investmentweek.co.uk/news/4021215/asset-classes-protect-
portfolios-negative-interest-rates

Financial Times. (2020). BoE asks banks how ready they are for negative rates. Retrieved
from https://www.ft.com/content/7994e660-eaf0-40d5-a631-5b7663f16ceb

Inman, P., Elliott, L. (2020). Bank of England paves way for negative interest rates. Retrieved
from https://www.theguardian.com/business/2020/may/20/uk-sells-government-bond-
with-negative-yield-for-first-time-coronavirus

Jurkšas, L. (2017). AN IMPACT ASSESSMENT OF NEGATIVE INTEREST RATES OF

CENTRAL BANKS. Ekonomika, 96(1), 25-46. doi:http://dx.doi.org.ezproxy.napier.ac.uk/
10.15388/Ekon.2017.1.10662

Schroders. (2020). Negative rates explained: should UK investors prepare? Retrieved from
https://www.schroders.com/en/uk/private-investor/insights/economics/what-happens-if-
uk-interest-rates-turn-negative/

Szalay, E. (2020). Pound drops after BoE ‘explores’ negative rates. Retrieved from https://
www.ft.com/content/1124fbd1-0142-4309-ada8-e1563e64c50d

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Tokic, D. (2017). Negative interest rates: Causes and consequences. Journal of Asset
Management, 18(4), 243-254. doi:http://dx.doi.org.ezproxy.napier.ac.uk/10.1057/
s41260-016-0035-2

Trading Economics. (2020). Gold. Retrieved from https://tradingeconomics.com/commodity/

gold

Yoshino, N., Taghizadeh-Hesary, F., & Miyamoto, H. (2017). The effectiveness of the
negative interest rate policy in japan. Credit and Capital Markets, 50(2), 189-212.
doi:http://dx.doi.org.ezproxy.napier.ac.uk/10.3790/ccm.50.2.189

Ziegler-Hasiba, E., & Turnes, E. (2018). Negative interest rate policy in switzerland.
Entrepreneurial Business and Economics Review, 6(3), 103-128. doi:http://
dx.doi.org.ezproxy.napier.ac.uk/10.15678/EBER.2018.060307