What Lower European Interest Rates Really Mean

March 15, 2016

The European Central Bank recently cut its interest rates across the euro zone to zero to boost measures amid global economic downturn. The cutting of interest rates was also to expand its money printing strategy and to reduce a main bank deposit rate further into negative territory.

But what does this cutting of rates really mean?

Well, other than to boost measures, a reduction in interest rates basically means that people who borrow money will be privileged to enjoy an interest rate cut.

Cutting interest rates also means that those who lend money, or buying securities likeВВВВ bonds, have reduced the opportunity to make profit from interest.

Let’s assume investors rational, a cut in interest rates will make investors move money away from the bond market to the equity market. Also, businesses will benefit the ability to finance expansion at a lower rate, therefore elevating their future profits potential, which will cause stock prices to go up.

Moreover, the merging effect of an interest rate cut is that consumers and investors will view it as a benefit to personal and corporate borrowing, leading to better earnings and an expanding economy.

But what if rates reach negative territory?

So are negative rates considered good or bad? Well, negative rates, which will charge banks to deposit money, have a big impact on banks’ earnings as they can’t be passed on to customers.

In other words, the European Central Bank, once reached negative rates, can charge customers for keeping their savings in the bank. The same way central banks are now charging commercial banks for keeping their money. It could also have a huge impact on the forex markets, as lower interest rates put downward pressure on the European Currency Unit.

The worst thing that could happen is it could make a run on the banks in Europe with consumers keeping their money rather than paying interest on deposits.

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