Low Interest Rate Policy

What does low interest rate policy mean?

A low interest rate policy covers all measures by which a central bank lowers the interest rate level of its currency or keeps it low. It is also known as loose, accommodative or expansionary monetary policy, and central bankers who favour it are called "doves". It is the counterpart of a high interest rate policy.

Goals and effects

The main aim is usually to fight deflation by increasing the amount of money in circulation. The central bank also wants to encourage investment, because loans in the home currency become cheaper. If the rate on a $100,000 loan falls from 6% to 2%, for example, the annual interest cost drops from $6,000 to $2,000, and projects that were not viable before may now pay off.

After the financial crisis of 2008, central banks intervened on a large scale and kept interest rates low for years to support the economy and prevent an even deeper recession. Key rates were cut close to zero, and some central banks, including the ECB, the Swiss National Bank and the Bank of Japan, even introduced negative rates for a time. Many also bought bonds on a large scale (quantitative easing). The risks of a long period of cheap money include rising debt, asset price bubbles and, eventually, higher inflation.

Why it matters for traders

Low interest rates tend to weaken a currency because investments in it earn less. Such currencies are often used to fund carry trades, in which traders borrow in a low-yielding currency and invest in a higher-yielding one. Cheap money also tends to support stock indices. In forex and CFD trading, the interest rate level affects the swap on positions held overnight, so signals of rate cuts are closely watched.