There are “no limits” to how far central banks can ease monetarypolicy.

That's a recent declaration of both European Central BankPresident Mario Draghi and Bank of Japan Governor Haruhiko Kuroda,who have joined their counterparts in Denmark, Sweden andSwitzerland in embracing interest rates of less than zero.

In September 2014, when the ECB's deposit rate was minus 0.2percent, Draghi was saying, “Now we are at the lower bound.” Asrecently as December, Kuroda said, “We don't think we shouldinstitute” negative rates.

The rethink is global, even in places where rates are stillpositive. Bank of England Governor Mark Carney conceded in Novemberthat his benchmark could fall below the current 0.5 percent ifneeded, while Federal Reserve Vice Chair Stanley Fischer said lastweek that negative rates were “working more than I can say that Iexpected in 2012.” Citigroup Inc. economist Willem Buiter says evenChina could shift below zero next year.

The worry had been that probing below zero risked hurting theprofitability of lenders, forcing them to pass on the cost toborrowers. Other fears included bank and currency runs, thehoarding of cash or gridlocked money markets.

Rather than spurring lending and spending as intended, subzerorates would become more a problem than solution. Such a concerncould still flare up anew given the recent selloff in global bankstocks and fretting over financial titans such as Deutsche BankAG.

So in this brave new world, how much lower can rates now go?According to an analysis published late on Tuesday by economists atJPMorgan Chase & Co., way, way lower.

Having studied the lack of fallout in Switzerland, where thebenchmark rate is minus 0.75 percent, Malcolm Barr and Bruce Kasmanreckon the trick lies in a tiered system as already deployed by theBank of Japan and in some places of Europe, whereby only a portionof reserves are subjected to negative rates.

On that basis, they estimate if the ECB just focused on reservesequivalent to 2 percent of gross domestic product it could slicethe rate it charges on bank deposits to minus 4.5 percent. Thatcompares with minus 0.3 percent today and the minus 0.7 percentJPMorgan says it could reach by the middle of this year.

The Bank of Japan's lower bound on a similar basis may be minus3.45 percent, while Sweden's is likely minus 3.27 percent, theeconomists said. Should they also go negative, the Fed could cut tominus 1.3 percent and the Bank of England to minus 2.69 percent inJPMorgan's view, reflecting how the ratio of reserves to assets ishigher in their economies than elsewhere.

Out of Ammunition

Concentrating on 25 percent of reserves would allow the ECB tocut to minus 4.64 percent and the Fed to minus 0.78 percent. Makingno change to the current regime would allow Draghi to lop to minus1.36 percent, they said.

Easing the fall is that the JPMorgan economists bet that banksare unlikely to be able to pass on the cost of the policy toborrowers, reducing potential repercussions. They also see limitedpressure on bank profits or for a need to stash cash.

While Barr and Kasman still expect policy makers to treadcarefully, such analysis may temper the recent fear of investorsthat after seven years of interest rates around zero and bumperbond-buying, central banks are now out of ammunition. Indeed, afuller embrace of negative rates could “produce significantreductions in market rates,” said the economists.

“It appears to us there is a lot of room for central banks toprobe how low rates can go,” they said. “While there aresubstantial constraints on policymakers, we believe it would be amistake to underestimate their capacity to act and innovate.”

Bloomberg News

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