After the financial crisis, Threadneedle Street cut borrowing costs to a 300-year low by cutting interest rates by five percentage points. rates throughout the year.
Many experts believed that the cost of borrowing would be permanently lower.
This belief is still widely held. Economists, including those at the Bank of England and the International Monetary Fund, still argue that after this bout of high inflation, rates will eventually return to post-crisis lows.
But as the fight to cool the economy drags on, voices of dissent become louder.
Megan Green, an economist with the Bank of England's rate-setting group, warned earlier this week that ultra-low rates are by no means guaranteed.
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It would be “a mistake for central bankers to take comfort in the fact that inflation and rates will automatically return to the low levels we saw before the pandemic,” she warned.
The implications of being right are huge for the economy.
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Persistently higher interest rates will raise the cost of borrowing for post-pandemic debt-heavy governments and make servicing mortgages much more expensive.
According to the Office of Financial Responsibility, increasing percentage points of borrowing costs reduce the Treasury's purchasing power by 10% annually, according to the Office of Financial Responsibility. £20 billion.
To put this into perspective, Chancellor Jeremy Hunt has kept only a wafer for himself. a meager £6.5bn budget buffer by 2028.
In the US, interest rates at the Federal Reserve have begun to raise their expectations of where borrowing costs will stabilize in the long run, barring some major shock.< /p>
All of these factors depend on at what level central banks can set interest rates without spurring or restricting demand.
One of the most prominent economists to argue that interest rates are moving higher is Charles Goodhart, a former member of the Bank's monetary policy committee.
Rising protectionism amid tensions between the US and China and a shrinking workforce as the population ages are among the key factors that will drive up prices and thus interest rates, he says.
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He believes that in the long term, interest rates will hover around 4.5%, just slightly below the current level of 5%, the highest cost of borrowing since the financial crisis.
“If you want to understand the future, you have to understand the past,” he says.
Interest rates have been falling quite steadily since the 1990s until Covid hit.
Many economists believe that this is because of an aging population, which contributes to higher retirement savings and slower productivity growth.
Andrew Bailey, Governor of the Bank of England, made this argument in a speech back in March.
Households that actually lend money to banks by placing their savings in them will do so to a much greater extent.
Thus, rewards, ie interest-bearing savers, will fall.
Others, such as Goodhart, whose interpretation of the past differs from Bailey's, argue that the ratio of working to inactive people will fall. Some economists also point out that older people tend to spend most of their income on services because they don't have a mortgage.
“The last three decades, roughly from 1990 to 2020, have been historically unusual,” says Goodhart. says.
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Beneficial geopolitical events such as the collapse of the USSR, the rise of China and the rise of the labor force have led to “much smaller increases in prices and wages than usual,” he says.
“Instead of maintaining the norm of the last 30 years, we will face the opposite situation, where labor will be much more difficult and difficult,” he adds.
Other trends. Higher defense spending and the massive investment required to fund zero transition will also add to inflationary pressures, he said.
The government is increasing defense spending by £11bn over the next five years. , a decision taken after Russia's invasion of Ukraine.
Meanwhile, ministers are forced to unveil the UK's response to the $369bn (£290bn) US Inflation Reduction Act and the EU Green Deal, which funnel huge amounts of borrowing towards net zero.
Labour recently abandoned its plans to borrow £28bn a year for the same purposes amid rising borrowing costs.
Berenberg's Callum Pickering says: 'We are greening our economy much faster than the relative price of “green” technologies. it would be if the market were left to its own devices, and therefore it is an inflationary factor.”
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Pickering expects the BoE base rate to settle at 3% to 4% over the long term, well above the average of the last 15 years.
While technological advances such as the rapid growth of artificial intelligence can lead to lower productivity, but it also affects interest rates.
“Technological development has a disinflationary effect on the sector it affects,” Pickering says. “But if these technological developments are large enough to significantly improve living standards, it is often found that the confidence effect increases demand more than technology increases supply.” revolutions in the past have tended to be inflationary rather than disinflationary.”
Analysts at BNP Paribas have recently warned that while they still believe interest rates will trend lower in the coming decades due to increase in pension savings, they are likely to grow in the near future.
They argued that the remarkable resilience of economies such as the UK, the US and the eurozone in the face of soaring rates suggests that the level at which interest rates do not cap or stimulate demand could shift upward.
“This suggests limited scope for rate cuts without over-stimulating the economy, raising the risk that inflation will pick up again once central banks ease the brakes,” they said.
that a sustained return of inflation to 2% could be a difficult task.”
Economists who believe that interest rates will remain permanently high are still in the minority.
But if they you're right, it creates unpleasant prospects. problem.
“We already have very high debt ratios, and they will rise. It's going to be a fiscal problem that no one has ever faced before,” says Goodhart.
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