Markets have three main concerns with negative interest rates:
• First, negative interest rates may directly harm the banking sector. Commercial banks make money by charging a higher rate of interest on loans than they pay on deposits – that is, they have a positive net interest margin. But if the rate charged on loans is being squeezed ever lower by falling policy interest rates, and commercial banks are unwilling or unable to set the rate paid on deposits below zero for fear that depositors will withdraw money and hold it as cash, banks' net interest margin is compressed tighter and tighter;
• Second, negative interest rates may represent another escalation of a futile currency war. A weaker exchange rate, which boosts import prices and therefore inflation, certainly appears to be a key channel through which monetary policy easing is acting. But currency devaluation is a zero-sum game: the global economy cannot engineer a currency devaluation against itself. Taken to the extreme, competitive currency devaluations may give way to protectionist trade policies, which would be negative for global growth;
• Third, negative interest rates may be symptomatic of central banks reaching the limits of what monetary policy can do. Markets appear to be increasingly concerned that central banks are out of ammo, and are fretting about how policy makers would tackle another downturn.