Economics, 101 - Is negative inflation a good / bad thing?

[desprateseagull]

http://www.mirror.co.uk/news/uk-news/inflation-drops-below-zero-first-5521538

CPI now at MINUS 0.01% - does that mean prices will be falling, or just wages..?

 

[The Maharajah of Sydney]

In Europe with inflation turning into deflation resulting in negative interest rates some banks are PAYING mortgage borowers that have been loaned funds - a totally unforeseen dynamic.

Negative rates in Europe: banks may pay borrowers

http://www.wsj.com/articles/as-inte...ve-banks-may-have-to-pay-borrowers-1428939338


Negative interest rates in Europe have created a previously inconceivable problem for some banks: They may soon have to pay interest to customers who borrow from them.

In countries such as Spain, Portugal and Italy the base interest rate used for many loans, especially mortgages, is Euribor, which stands for the euro interbank offered rate. Euribor is based on how much it costs European banks to borrow from each other. This benchmark and others like it have been falling sharply, in some cases into negative territory, since the European Central Bank introduced measures last year meant to boost the eurozone economy.

Because banks set interest rates on many loans as a small additional percentage above or below a benchmark such as Euribor, the tumbling rates are leaving some banks facing the paradox of actually owing interest to borrowers. At least one bank, Spain’s Bankinter SA, has been paying some customers interest on their mortgages by deducting that amount from the principal the client owes.

The novel problem is just one of many challenges caused by negative interest rates. All over Europe, banks are being forced to rebuild computer programs, update legal documents and redo spreadsheets to account for negative rates.

Banks, hoping to avoid the expense of having to pay their borrowers, are turning to central banks for guidance. But what they are hearing is less than comforting.

Portugal’s central bank recently ruled that banks would have to pay interest on existing loans if Euribor plus any additional spread falls below zero, although banks are free to take “precautionary measures” in future contracts. More than 90 per cent of the 2.3 million mortgage contracts outstanding in Portugal are variable rate and linked to Euribor.

In Spain, a spokesman for the central bank said it is studying the issue. The vast majority of Spanish home mortgages have rates that rise and fall tied to 12-month Euribor, says Irene Peña, an economist with Spain’s mortgage association. That rate currently stands at 0.187 per cent.

Bankers in Italy say they are awaiting guidance from their local banking association, because loan contracts don’t include any clause on what happens if benchmark rates go negative. About half of the mortgages outstanding in Italy have variable rates, most of them linked to Euribor, according to local mortgage broker Mutuionline.

Bankinter, Spain’s No. 7 lender by market value, has been forced to chip away at some clients’ mortgage principal payments since another interest-rate benchmark tied to Switzerland’s currency has dipped into negative territory. During Spain’s home-building frenzy in the mid-2000s, Bankinter issued mortgages tied to the one-month Swiss franc iteration of the London interbank offered rate, or Libor. At the time, clients were attracted to the offer because Swiss franc Libor was lower than Euribor, the traditional reference for Spanish mortgages.

“I’m going to frame my bank statement, which shows that Bankinter is paying me interest on my mortgage,” said a customer who lives in Madrid. “That’s financial history.”

The client in 2006 took out a roughly €500,000 ($US530,000) home mortgage loan based on Swiss franc Libor, plus 0.5 percentage point. Since then, Swiss franc Libor has fallen far enough into negative territory to make his mortgage rate negative.

It is hardly a windfall for this customer, however, because, while Swiss franc Libor has fallen, the Swiss franc itself has risen in value against the euro. That means the value in euros of the total mortgage debt he owes Bankinter has also increased, since that debt is denominated in Swiss francs.

Bankinter has “few” such mortgages tied to a negative Libor rate, a spokesman said, declining to provide a figure.

An executive at another Spanish bank said the lender in recent months has started to put in place an interest-rate floor on thousands of short-term business loans that are tied to short-term variations of Euribor. Two-month Euribor, for instance, is at -0.004 per cent. For new loan contracts, the bank is increasing the cushion it charges customers above Euribor.

Hundreds of thousands of additional loan contracts would be affected if medium-term Euribor rates enter into negative territory, the executive added. The six-month rate, for instance, is currently at 0.078 per cent.

A Madrid judge last November ruled against a client of Banco Santander SA who claimed that Spain’s largest bank inappropriately established a floor on his mortgage in 2013 and therefore owed him money. The plaintiff had taken out a mortgage in 2005 that offered a fixed rate of 2 per cent in the first year and Euribor minus 1.1 percentage points thereafter. The plaintiff said he was now owed money from the bank.

To buttress his argument that a bank shouldn’t have to pay a borrower for a loan, the judge quoted from a June 2014 statement from the Bank of Spain that “a payment in favour of the client in these situations would never apply, but rather the application of an interest rate of zero by the entity.” The Bank of Spain spokesman said that the statement cited in the case was issued by the central bank’s customer-complaints service, which typically responds to particular cases. The Bank of Spain hasn’t issued a system-wide decision on how banks should treat negative interest rates, he added.

In Portugal, interest rates on most mortgages are linked to a monthly average of three- and six-month Euribor. Both have been steadily sinking and currently are hovering just above zero.

João Coelho da Silva, a 53-year-old real-estate agent in Lisbon, has seen his mortgage payments fall from about €450 a month when his contract began in 2008 to €235 now, thanks to a falling three-month Euribor.

“With the economy in such a bad state, these monthly savings are more than welcomed,” Mr da Silva said.