Will Negative Loan Rates Boost Gold?

Friday, April 1, 2016

Negative interest rates go further and further, as some banks introduced negative loans rates. What are they and what do they mean for the gold market?

How Do Negative Loan Rates Work?

We have all heard about negative deposit interest rates introduced by central banks and some commercial banks. Now, the idea of going below zero is extended to loans. Yeah, it sounds like madness, but it is actually true. A few European banks implemented such products last week. How do they work? Well, in normal times borrowers have to pay for the granted loans. Now, it’s just the opposite – commercial banks pay their customers for graciously taking loans.

How Did It Happen?

How did it happen? Nobody should be surprised – it is just another unintended effect of unconventional monetary policies. As you probably remember, the European Central Bank cut interest rates and extended its asset-purchase program in March. In particular, Draghi introduced the second round of Targeted Long-Term Refinancing Operations. These are loans for commercial banks conditional upon their net lending to the real economy. Importantly, the ECB decided to charge interest on these operations from “0” percent to “as low as the interest rate on the deposit facility”. Given that the deposit rate is below zero, Draghi will pay commercial banks money for lending money in TLTRO II. It will be the first case of lending at negative rates. The idea of that program is to incentivize bank lending to the real economy (the more the banks lend, the bigger and cheaper the ECB loans). However, there is one small problem. Europeans do not want to take out new loans (since they are already excessively indebted). Here come negative loan rates – banks want to convince their clients to borrow to get extra money from the ECB. “This is the best proof that our monetary policy always worked, works and will work, by supporting lending to the real economy”, said Draghi when asked about negative loan rates this week.

Two Birds With One Stone

In this way, European banks also want to kill two birds with one stone. By introducing negative loan rates they could not only boost their lending and take extra money from the ECB, but also introduce negative deposit rates. If they simply lowered the deposit rates, they would risk the loss of customers. This is why they decided to simultaneously charge clients negative interest rates on their deposit and pay them money for lending money. In other words, negative loan rates were implemented to compensate the customers for the extra costs of negative deposit rates.

Negative Loan Rates And Gold

How will negative loan rates affect the price of gold? On the one hand, the impact should not be significant, given the marginally negative loan rates (they do not exceed -1 percent) and the scope of the phenomenon limited to a few European banks. Additionally, nobody knows for sure whether negative loans rates would be effective since even negative loan rates might not convince people to take more loans, especially if the economy lacks profitable investments on the horizon. On the other hand, negative loans rates, if expanded, will turn the economy upside down, which could boost the safe-haven demand for gold. Moreover, if negative loan rates work, they will imply massive lending to the economy and, thus, rampant inflation. In such a scenario, the yellow metal should shine. The price of gold would skyrocket, perhaps to $2,000 or even more, according to Peter Schiff at Euro-Atlantic Capital. We are more skeptical regarding the price outlook (since the European banking madness should also strengthen the US dollar). To be sure negative loan rates are certainly bullish for gold.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold -- but this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium-term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) -- and rest assured we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Arkadiusz Sieroń is the author of Sunshine Profits’ monthly Gold Market Overview report, in which he keeps subscribers up-to-date regarding key fundamental developments affecting the gold market and helps them prepare for the major changes. Arkadiusz is a certified Investment Adviser, a long-time precious metals market enthusiast, and a Ph.D. candidate. He is also a Laureate of the 6th International Vernon Smith Prize.  You can reach Arkadiusz at Sunshine Profits’ contact page.