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Negative Rates, Part 1: Unexpected Ways Negative Interest Rates Influence Currency Exchange Rates

By Frances Coppola

A country’s currency exchange rate can reflect its economic prospects. Economic theory says that when the economic outlook for a country is bright, expected returns on investment rise. And as investors attracted by those higher returns move money into the country, its currency exchange rate rises versus other currencies. Conversely, when a country is experiencing an economic downturn, expected returns on investment fall; investors move their money to other countries where prospects are better and currency exchange rates fall.

However, the real world doesn’t always behave neatly according to economic theory. In particular, exchange rate behavior has been unpredictable as negative interest rates have emerged in different parts of the world. Consequently, businesses engaged in importing or exporting in the current global economic environment could choose to observe a broader span of macroeconomic and market conditions in order to anticipate foreign exchange rates.


The Theoretical Interest Rate-Exchange Rate Relationship


Ever since the 2008 financial crisis, central banks around the world have tried to generate recovery by cutting interest rates. In the last eight years, major central banks have cut rates on average every three days.1 Therefore, interest rates in developed economies are at historic lows – and some countries are experimenting with negative rates. Cutting interest rates is supposed to encourage businesses to borrow for investment while encouraging people to spend rather than save money, thus increasing economic activity and generating jobs and growth. It is unclear how successful this approach has been: some say that without this central bank intervention the situation would be worse, while others say there should be greater use of fiscal policy (tax cuts and government spending).2


Although cutting interest rates is primarily intended to influence domestic businesses and households, it also has an effect on trade. When central banks cut policy interest rates, currency exchange rates tend to fall. In 2008, for example, when the Bank of England cut its base rate from 5 percent to 0.5 percent, sterling’s exchange rate fell by as much as 25 percent against all major currencies.3 Similarly, after the European Central Bank (ECB) introduced negative rates on bank reserves, the exchange rate of the euro versus the U.S. dollar fell continually over the next few months.4


Falling currency exchange rates tend to encourage exporters and discourage importers, which improves a country’s competitiveness and can help it recover from a downturn. Conversely, rising exchange rates discourage exports and encourage imports. Manipulating currency exchange rates to gain an export advantage is contrary to the International Monetary Fund’s (IMF’s) Articles of Agreement.5 However, if the currency exchange rate falls as a consequence of monetary policy intended to benefit the whole economy, not just exporters, it is usually accepted by trade partners and by the IMF.


But exchange rates and their ripple effects don’t always behave as expected. In the case of the Swiss franc, they appeared to do the opposite.


The ECB and the Swiss Franc Exchange Rate


Switzerland has long been regarded as a “safe haven” by investors due to its stable economic history and long tradition of secure banking. During the Eurozone crisis of 2012, worried investors moved money out of certain other countries and into Switzerland’s calmer environment, causing the Swiss franc to rise sharply versus the euro. Because a sharp rise in exchange rate is bad for exporters, on which Switzerland’s economy depends, the Swiss National Bank (SNB) imposed a cap on the exchange rate at 1.20 francs to the euro. It did this by issue large quantities of francs, which it sold in exchange for euros and euro-denominated assets.6


But when the ECB announced its intention to start quantitative easing (QE), the SNB decided that it could no longer hold the cap. On January 15, 2015, it lifted it. At the same time, it slashed interest rates to minus 0.75 percent, at that time one of the most deeply negative interest rates in the world, expecting that the negative rate would prevent its currency from rising.7


It did not work out as expected. The franc’s exchange rate versus the euro jumped when the cap was lifted. By close of business that day, one euro bought less than one franc – a depreciation of about 20 percent. Meanwhile, franc LIBOR – the rate at which banks lend Swiss francs to each other on the London market – dropped to almost minus 1 percent. The SNB 0.75 percent negative rate was not enough to deter investors from moving money out of euros and into francs.8


Despite persistently negative interest rates, the Swiss franc’s exchange rate has remained elevated. But its export trade did not noticeably suffer. In fact, according to a European Commission report, exports for all of 2015 rose 12 percent over 2014, and at the end of 2015 Switzerland’s trade in goods surplus was 34.6 billion euros and its current account balance (which includes trade in services and investment income as well as trade in goods) was 11.4 percent of its GDP.9


Despite economic theory, negative interest rates and a high currency exchange rate did not appear to deter export trade. And Switzerland is not the only country where negative interest rates have had unusual effects on the exchange rate.


Japan’s Rising Yen


For more than two decades, Japan has been stuck in a deflationary economic slump.10 The “three arrows” introduced by the government of Shinzo Abe in 2012 – monetary policy, fiscal policy and structural reforms – continue to miss their targets, as several rounds of QE and rising government spending have had little more effect than to increase Japan’s sovereign debt. In January 2016, the Bank of Japan dropped its opposition to negative rates, cutting its deposit rate to minus 0.1 percent.11


While Japanese policy makers expected the negative interest rate to apply downwards pressure on the yen’s exchange rate, the yen actually rose to 18-month highs against the U.S. dollar.12 Like the Swiss franc, the yen has traditionally been regarded as a safe haven by investors, particularly those worried about the state of the U.S. economy. Because 2016 has been a turbulent year for global markets, and the U.S. economy has not performed as well as expected, investors have been moving money out of dollars into yen thus causing the yen exchange rate to rise – despite the negative rates.13



Exchange rates are not always a good indicator of the economic strength of a country. For some countries, such as Japan and Switzerland, the exchange rate can depend much more on the outlook for the world economy, the fears investors have and the behavior of neighboring countries. Businesses trading with these and other “safe haven” countries may wish to explore a broader spectrum of global macroeconomic and market conditions when planning their FX risk management strategy.

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.


1. “Major central banks have cut rates 672 times since Lehman”, Financial Times;
2. “Buttonwood’s Notebook: Five Years On", The Economist;
3. Explanation beyond exchange rates: trends in UK trade since 2007, U.K. Office for National Statistics;
4. Negative interest rates in Europe: A Glance at Their Causes and Implications, The World Bank;
5. Articles of Agreement of the International Monetary Fund, International Monetary Fund;
6. “Oh Switzerland, What Have You Done?”,;
7. Ibid
8. "S’weird in Switzerland", The FRED [Federal Reserve Bank of St Louis] Blog;
9. Switzerland, European Commission trade report;
10. "Japan's three arrows of Abenomics continue to miss their targets", The Guardian;
11. "Bank of Japan Introduces Negative Interest Rates", The Wall Street Journal Online;
12. "Japan’s Negative-Rate Experiment Is Floundering", The Wall Street Journal Online;
13. Ibid

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