CENTRAL banks are dragging their benchmark borrowing costs deeper into negative territory, punishing financials and dragging more than $6tn of top tier government debt below a yield of zero per cent.

What are they doing?

It is officially known as the negative interest rate policy or Nirp, and it is eclipsing a zero policy, or Zirp.

Slumbering inflation pressures and the risk of deflation are worries for policymakers, who want to jump-start growth and help consumers, companies and governments pay down their debt

Switzerland and Denmark have led the charge, while on February 11, Sweden’s Riksbank upped the ante by cutting its main repo rate to minus 0.5pc.

The Bank of Japan’s recent entry into the Nirp camp with minus 0.1pc for some reserves has fanned expectations that it has just started a foray below zero.

In the coming months the European Central Bank’s deposit rate is expected to head lower from its current minus 0.3pc.

Why are they doing it?

Slumbering inflation pressures and the risk of deflation are worries for policymakers, who want to jump-start growth and help consumers, companies and governments pay down their debt.

After the financial crisis global interest rates fell and central banks, led by the US Federal Reserve and the Bank of England, resorted to quantitative easing, buying massive amounts of government debt.

For all that, inflation remains below targets, a trend that is being reinforced by the collapse in commodity prices and concerns over a slowing global economy.

Can rates go much lower?

In theory there is no limit. But the task of the BoJ and the ECB is being complicated by stronger currencies.

Negative rates are viewed as one of the most effective ways to weaken a currency and thus boost inflation expectations, but the opposite is happening for both the euro and the yen.

After a torrid start to the year led by miners and commodity producers, global equities are being hammered with financials bearing the brunt of selling.

Could debt write-offs loom? The dash towards negative interest rates does not seem to be working, leaving markets in a state of flux

What are the consequences?

A negative rate environment is bad news for bank profits. And in Japan, Europe and the US, share and bond prices for banks have slumped. This runs counter to what Nirp is supposed to achieve.

Negative deposit rates are seen as complementing QE by forcing banks to seek more risky lending opportunities and assets to compensate for losses on their interest rate margin.

This ‘portfolio rebalancing effect’ should, in theory, spur growth by providing funds to credit-starved parts of the economy and reduce the cost of borrowing for riskier sovereigns and companies.

So where are investors putting their money?

About $6tn of government debt sold by Japan and countries in Europe yields below zero. Roughly two-thirds of Japanese government bonds are negative yielding, while in Germany the 10-year Bund yield is just 0.16pc.

Investors are selling equities and corporate bonds and buying sovereign debt that still has a positive yield. This week there have been dramatic rallies in US and UK bond prices, pushing their 10-year yields below 1.60pc and 1.3pc respectively.

Why would you buy a negative-yielding bond?

Call it the ‘greater fool’ theory of investing.

Buying negative-yielding bonds entails a guaranteed loss if held to maturity. But a trader can still make a profit by selling at a higher price so long as someone else thinks central banks will keep pushing yields further below zero.

Published in Dawn, Business & Finance weekly, February 22nd, 2016