Interest rates are falling again, when will we learn? This time it really is different

The interest rate cycle is turning — unbelievably it is turning down. Investors need to understand, it is different now.

Article updated: 12 July 2019 10:00am Author: Michael Baxter

According to Nat King Cole, love is over before it has begun. Well, in a restless world like this is, it seems interest rate cycles are over before they have begun — too.

When you think about it, this really is staggering. US interest rates are in the 2.25 to 2.5 per cent range, and they appear to have peaked.

The latest minutes from the FOMC — the US rate setting committee at the Federal Reserve — were so dovish that it is a wonder that the residence of the dovecote aren’t partying throughout the night.

At the European Central Bank, the doves have been partying for years, the latest words from its outgoing President, Mario Draghi, seem to have been designed to hold the most magnificent spectacular for the doves who like to party. No doubt, Christine Lagarde, the President in waiting, will coo just as much. The interest rate across the Eurozone stands at a massive 0.25 and minus 0.4 per cent.

As for the Bank of England, things are a tad different. With rates standing at a debilitating 0.75 per cent, the MPC, its rate setting committee, seems keen to increase rates at some point in the next thousand years, who knows, maybe they will reach the giddying heights of one per cent one day in the distant future. Brexit muddies the water, with sterling trying to impersonate a man falling out of an aeroplane, the Bank of England may need to up rates sooner, maybe at the time the UK leaves the EU, so that’s definitely maybe this side of the year 3000.

And by the way, if you like to take risks with your bond buying, why not buy bonds drawn on the Polish or Czech governments, you can enjoy a juicy negative return.

Even Italian ten-year bonds are yielding less than two per cent.

In the aftermath of the 2008 crash, when interest rates were slashed either to zero or near zero, and central banks took to the virtual printing press via quantitative easing, the wise men and women told us that inflation was inevitable — that when rates rose, which they inevitably would, it would all end in tears.

In 2012, Bundesbank president Jens Weidmann likened QE to a Faustian pact — that hyperinflation would follow QE as surely as night follows day.

Well, record low interest rates have had negative consequences, but inflation isn’t one of them. Maybe record low rates have distorted asset prices, maybe they have increased wealth inequality, maybe they have created zombie companies, but inflation is about as threatening as six week old puppy wagging its tail.

You can ask why. Some are now arguing that it has become self-reinforcing — that central banks have created an environment in which interest rates can never increase that much.

Personally, I think central banks have much less power than they are generally supposed to have.

No, rates are low because inflation is low, and inflation is low because globally, there is a chronic shortage of demand.

Why is that? Maybe because the retirement of the baby boomers has led to a global savings glut. Maybe, because of growing inequality, maybe because globalisation has increased global profits at the expense of wages.

Maybe because of technology.

Whatever the reason, more than ten-years after the 2008 crash the interest rate cycle seems to have peaked, even though it has barely moved.

I suspect that austerity exacerbated the problem. Cutting back on government spending at a time when governments can borrow for next to nothing made no sense. But the trouble is, no country can break the austerity deadlock on its own. If George Osborne had opted for high borrowing and a massive Keynesian stimulus instead of austerity, the pound would have fallen, just like it threatens to do now.

No, such policies would only work if they are tried globally.

But it will happen. One idea doing the rounds at the moment and which is gathering some support from US Democrats is MMT — modern monetary theory. This involves governments borrowing at zero per cent, spending lots and lots of money, and using taxation policy to fight inflation. It is massively controversial.

But technology is changing the world. The fourth industrial revolution is likely to create an even bigger gap between potential economic capacity and demand.

The era of ultra low interest rates may not last another millennium, but it will last for decades, policies like MMT (but maybe slightly different) are inevitable.

Investors need to understand, record low rates are here to stay.


These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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