Introduction Interest rates are one of the most important factors for the everyday life of private persons,

investors and businesses, as it directly influences at what cost you can acquire cash. This essay will describe what interest rates are and how they are set, determine their importance in a Central Banks monetary policy as well as evaluate the effects of those rates. Further, the essay will define what ne ative real interest rates are and e!amine the impact of ne ative real interest rates on the economy. Important parts of the economy, such as financial markets and trade, will be studied in more depth in order to truly be able to understand the chan es in trends such rates encoura e when it comes to investments and capital allocation. "astly, the report will assess the potential impact that ne ative real interest rates have on the shippin industry, more specifically the demand for transportation which in the end affects the frei ht rates that ship owners et for their vessels. What are interest rates? Interest rates are often referred to as #the price of money$. They are, however, more precisely defined as the price paid by a borrower for the acquisition of funds from a lender %&llivierre, "., '()*a+ Investopedia, '()*a,. Interest rates are added to a loan because of the principle of time value of money, as the lender fore oes the use of his funds for a iven period of time. Time value of money means that a iven sum of money is worth more in the present than the same amount in the future, due to the earnin potential of that money, as lon as the money is eli ible to earn interest %Collinson -., '()*+ Investopedia, '()*b,. The investor needs compensation for three factors. The first bein not havin immediate access to the money, which means he does not have the opportunity to spend, invest or earn interest %Collinson -., '()*,. The second factor is that inflation decreases the value of money over time, also decreasin the lenders buyin power %Collinson, -., '()*,. .nd lastly the investor takes on risk by lendin money, for which he will also seek compensation in the form of interest rates %Collinson, -., '()*,. Interest rates are usually quoted as a percenta e, and more often than not it will be an annual rate %&llivierre, "., '()*a,. There are two types of interest rates. The nominal interest rate is the rate quoted by the lender, which will then be the amount the lender ains and the amount the borrower pays %&llivierre, "., '()*a,. The other type of interest rate is real interest rate. The real interest rate is the nominal rate less the inflation %&llivierre, "., '()*a,. For e!ample, if the nominal interest rate is )( /, and the inflation is ' /, the real value of the loan will be

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1 / %)( 2 ' 3 1,. The real interest rate represents the actual increase of the value of the money %&llivierre, "., '()*a,. Monetary policy Interest rates are also used as a tool for central banks in attempts to alter or direct developments and trends in an economy, and one of the most important effects of interest rates is the effect on money supply. In the 4nited 5in dom the interest rates are set by the Bank of 6n land, which is the central bank %&llivierre, "., '()*b,. The Bank of 6n land then lends out money to the commercial bank at the interest rate set, which in the 4nited 5in dom is referred to as the bank rate %Bank of 6n land, '()*,. The effect is then that the bank rate at which the commercial bank lends from the Bank of 6n land is likely to be reflected in the market as the cost that customers then borrow and save %&llivierre, "., '()*b,. 7hen interest rates are lowered the price of money becomes cheaper, which discoura es savin but encoura es borrowin %&llivierre, "., '()*b,. 8ence spendin and investin money becomes more attractive and there is likely be more money in circulation in the economy %&llivierre, "., '()*b,. 9ore money in circulation and more purchasin power means more demand for oods, and in time we e!pect to see increased prices, in other words inflation %&llivierre, "., '()*b,. &n the other hand, should inflation be too hi h, a scenario which typically happens when economic rowth is stron , we are likely to see hi her interest rates from the central bank in order to encoura e savin over spendin , thereby slowin down inflation rowth %&llivierre, "., '()*b,. The Bank of 6n land lists monetary stability as one of its two core purposes, which means stabile prices and investor confidence in the 0ound :terlin %&llivierre, "., '()*b+ Bank of 6n land, '()*b,. :tabile prices are in reality the inflation tar et set by the overnment, and the central bank will use interest rate as a tool in order to maintain these rates %&llivierre, "., '()*b+ Bank of 6n land, '()*b,. The other part of monetary stability, investor confidence in the 0ound :terlin , is also affected by the interest rates set by the Bank of 6n land. . rise in interest rates, especially if une!pectedly so and if a contrast to rates overseas, will make assets traded in the 0ound :terlin more attractive, acquirin more attention from forei n investors. This would require them to buy the 0ound :terlin , and this increased demand is likely to spark hi her value towards other currencies %&llivierre, "., '()*b+ Investopedia, '()*c,. There are, however, many other factors overnin the forei n e!chan e rates, and the movements of a currency

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are often very unpredictable and difficult to completely control %&llivierre, "., '()*b,. . hi her e!chan e rate, which means a more e!pensive 0ound :terlin , ives less forei n purchasin power, thereby causin a decreased demand for British e!ports. &n the other hand, however, it ives more purchasin power for British consumers and cheaper imports of forei n oods %&llivierre, "., '()*b,. The relationship between domestic inflation and movements in the 0ound :terlin , and in the ne!t instance imports and e!ports, is one of the most important evaluations the Bank of 6n land has to do when determinin the bank rate. Negative real interest rates -urin bad economic times, like the financial crisis, central banks will use interest rates to control the flow of money in the market. .s mentioned, the central bank will sometimes lower interest rates to encoura e more borrowin and spendin . 7e have recently seen nominal interest rates close to ;ero, which in reality provides little incentive of keepin your money in the bank as it will yield a very low return %&llivierre, "., '()*b,. <ot only does it yield a low return, should the inflation be at a hi her rate than the interest rate, savin s would in fact lose actual value %&llivierre, "., '()*b,. To put it in numbers, if the interest rate is ) /, with an inflation of ' /, the money will lose ) / of purchasin power.

Impact of negative real interest rates on the financial markets 7ith ne ative real interest rates, causin loss of purchasin power by savin your money in the bank, investors will seek to place their savin s elsewhere. Investments in equities and real estate become more attractive as investors need a hi her yield than what bank savin s can offer. It can be ar ued that low interest rates are a si n of future hi h yield in equities, as the stock e!chan e listed companies will benefit of the same low interest rates, providin access to money for future investments at a very low cost %Buttonwood, '()*,. In his blo on the economist, Buttonwood ar ues, however, that low interest rates are a si n of bad economic rowth, and that this cancels out the effect of access to cash at a low cost %Buttonwood, '()*,. In essence, this means that the investments are unlikely to yield a hi h return, as there is not enou h future demand to take full advanta e of the potential of those investments. It may therefore be ar ued that ne ative real interest rates are unlikely to have a direct effect on the movements of equities, on the other hand it is a known fact that increased demand is likely to equal increased prices. The increased demand for equities is therefore likely to spark

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a short=term hi her yield, however unlikely to be the backbone of stabile, lon =term yield %Buttonwood, '()*,. There is also likely to be a decline in demand for low risk investments, such as bonds %0erold, ..F., '()',. 7hen real interest rates are ne ative, holdin debt becomes unattractive, which is what bonds in reality are, the purchase of debt. 0erold ar ues that the only way for investors to avoid ne ative real return on your money, in a situation of ne ative real interest rates, is to seek out a risk at around > /, thereby e!posin themselves to substantial risk %0erold, ..F., '()',. In an investment portfolio of ?(@A( equities and bonds, iven the low, or in reality ne ative return on bonds, an investor would need a hi her return on his equities or increase his wei htin towards equities, thereby takin on increased risk %0erold, ..F., '()',. It may therefore be ar ued that ne ative real interest rates are likely to lead to lower returns on investments and hi her risk for investors in the financial markets.

Impact of negative real interest rates on world trade 7hen nominal interest rates reach such low levels that real interest rates are ne ative, it is a stron si n that the central bank is tryin to improve rowth in Bross -omestic 0roduct and increase trade. .s mentioned already, ne ative real interest rates discoura e savin s and encoura e borrowin and spendin , a spike in domestic trade is therefore likely. To comment movements in import and e!port are a little more difficult, as they are driven by movements in forei n e!chan e rates. Forei n e!chan e rates are typically harder to predict and do not always act rationally towards the interest rate %&llivierre, '()*b,. 8owever in an economy with ne ative real interest rates, the economys e!chan e rate is likely to decline %0hillips, C., '()),. This comes as a result of a probable low interest from forei n investors as ne ative real interest rates are likely to ive low return on investments of that economy %Buttonwood, '()*,. Biven the week e!chan e rate due to ne ative real interest rates, forei n purchasin power will increase, and thereby demand for e!ported oods. &n the other hand, there will be a loss in domestic purchasin power of forei n oods, causin a decreased level of imports %&llivierre, "., '()*b,. In essence, ne ative real interest rates in an economy, a re ion or as a eneral trend

worldwide would encoura e more borrowin and spendin , creatin increased demand for oods and trade in that area. -ependin on the areas where this impact would in fact be

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happenin , we could perhaps be e!posed to new trade patterns as stron economies could sei;e the advanta e of stron forei n currency positions to increase imports from new areas. Impact of negative real interest rates on shipping <e ative real interest rates are, as previously mentioned, a si n of bad economic times. 8istorically the shippin market has had very much a mirror ima e of the trends in world trade, as movements in world trade affect the demand for transport of oods. <e ative real interest rates also means that companies will have cheaper access to money, and you would e!pect to see an increased number of shippin companies takin the opportunity of favourable financin terms to purchase new vessels and increase investments %Buttonwood, '()*,. .nother important factor to look at for shippin companies is the movement in commodity prices. 7hen interest rates are low, we are likely to see a rise in prices for commodities such as oil, metals, and timber %Frankel, C., '()*,. &ne of the most important factors in this is the e!traction of those commodities. In a situation of ne ative real interest rates, there are fewer incentives for companies to e!tract commodities today because the cash you ain from the commodities is less valuable to you now %Frankel, C., '()*,. In addition to this, the commodities already held in stock become more attractive in stock than on the market. Both of these ar uments are based on the fact that cash is less valuable with ne ative real interest rates, therefore there is more value in holdin commodities than tradin them %Frankel, C., '()*,. 8ence we are likely to see a spike in commodity prices %Frankel, C., '()*,. This has an important influence on shippin as lower incentives for e!traction and hi her incentives to keep commodities in stock means that there will be lower amounts of commodities traded, and then eventually shipped. Based on these reflections from Frankel, one could easily ar ue the case that ne ative real interest rates are likely to encoura e less amounts of commodities in circulation, there by a decreased demand for transport which in the end means lower frei ht rates for ship owners. !onclusion Interest rates, or the price of money, are one of the most important economic factors and they affect everyone, both private persons and businesses, in the everyday life. Interest rates are set by the Central Bank, and the Central Bank uses interest rates as a tool for their monetary policy %&llivierre, "., '()*a,. <e ative real interest rates means that when you subtract inflation from the nominal rate, the real rate is ne ative, resultin in a loss of purchasin power %&llivierre, "., '()*,. <e ative real interest rates are a sure si n of a stru lin

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economy, they are however several important effects to be aware of in such situations. &verall, low interest rates means that access to money has become cheaper, and hence it will be cheaper and more attractive to borrow money for investments, both for private persons, investors and businesses %Buttonwood, '()',. In the financial markets, ne ative real interest rates are likely to attract investors to seek out investments with more risk, as cash is now of lesser value. 6quities and property is likely to become popular, but bonds and debt will become less attractive %0erold, ..F., '()',. For world trade this will have an impact on the forei n e!chan e rates, and evidently also the import and e!port patterns %&llivierre, "., '()*b,. This could cause chan es in trade lanes, and is an important development to look at for investors and shippin companies. For shippin in eneral, ne ative real interest rates make cheap cash more available, and investments in new tonna e easier. Commodity prices could also be heavily affected, and more importantly the amount of commodities in the market, directly influencin the demand for transport and frei ht rates. <e ative real interest rates are likely to cause lower frei ht rates as a result lower volumes of commodities chan in hands %Frankel, C., '()*,.

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$eferences Bank of 6n land, '()*a. Monetary Policy Framework DonlineE Dviewed '1.)).)*E available fromF httpF@@www.bankofen land.co.uk@monetarypolicy@0a es@[email protected]! Bank of 6n land, '()*b. Core Purposes DonlineE Dviewed '1.)).)*E available fromF httpF@@www.bankofen land.co.uk@about@0a es@[email protected]! Buttonwood, '()*. The 6conomistF Investing: The impact of low interest rates DonlineE Dviewed *(.)).)*E available fromF httpF@@www.economist.com@blo s@buttonwood@'()*@('@investin Collinson, -., '()*. MAR1 ! Investment theory" 9arine Finance. :outhampton :olent 4niversity, :outhampton, 4nited 5in dom. Frankel, C., '()*. 8arvard 4niversityF Monetary influences on commo#ity prices DonlineE Dviewed (*.)'.)*E available fromF httpF@@www.hks.harvard.edu@fs@[email protected] Investopedia, '()*a. Interest Rate $efinition DonlineE Dviewed 'A.)).)*E available fromF httpF@@www.investopedia.com@terms@[email protected] Investopedia, '()*b. Time %alue of Money &T%M' $efinition DonlineE Dviewed 'A.)).)*E available fromF httpF@@www.investopedia.com@terms@[email protected] Investopedia, '()*c. ( Factors That Influence )*change Rates DonlineE Hviewed '1.)).)*E available fromF httpF@@www.investopedia.com@articles@basics@(A@(>(I(A.asp "ewis, C., '()'. +ow ,altic $ry In#e* an# -egative Real Rates Make .ilver Attractive DonlineE Dviewed (*.)'.)*E available fromF httpF@@www.silverseek.com@commentary@low= baltic=dry=inde!=and=ne ative=real=rates=make=silver=attractive &llivierre, "., '()*a. +ecture /: Interest rates" International Trade and Finance. :outhampton :olent 4niversity, :outhampton, 4nited 5in dom &llivierre "., '()*b. +ecture (: Interest rates II" International Trade and Finance. :outhampton :olent 4niversity, :outhampton, 4nited 5in dom

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0erold, ..F., '()'. CF. InstituteF -egative Real Interest Rates: The Conun#rum for Investment an# .pen#ing Policies DonlineE Dviewed *(.)).)*E available fromF httpF@@blo s.cfainstitute.or @investor@'()'@(I@(*@ne ative=real=interest=rates=the=conundrum= for=investment=and=spendin =policies@ 0hillips, C., '()). 9inewebF 0ill gol# price go #own if interest rates rise1 DonlineE Dviewed *(.)).)*E available fromF httpF@@www.mineweb.com@mineweb@content@en@mineweb= old= analysisJoid3)'A>K'Lsn3-etail

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