2024-09-22 01:52:24
Households and businesses eagerly awaited interest rate cuts from the world’s major central banks as a necessary “breather” in an economic environment that, after two years of explosive inflation, is now experiencing the threat of recession.
Its ECB Christine Lagarde his Fed was also the first to move Jerome Powell followed with a jumbo – reduction. But how much will the policy relax? And especially for how much? Capital Economics tries to answer this question with its analysis.
Despite the fact that we have resounding warnings about the nightmare of recession, most notably that of the head of the ECB from Washington, for conditions reminiscent of the 1920sh Capital Economics estimates that a cycle of interest rate cuts will not last long, but will be completed next year. And in the coming years it is possible that we will see the cost of borrowing go uphill again. The era of abundant, cheap borrowing, of zero or even negative interest rates, has irretrievably passed.
What central bankers are “looking for” is the so-called equilibrium interest rate. What is it? A level of borrowing that will on the one hand prevent the rise of inflation, but on the other hand will not plunge the economy into recession, nor will it increase unemployment. For the next decade this interest rate in the developed world will be close to 3% to 4% and not zero as we were used to for more than a decade after the financial crisis of 2008.
Why do we care where interest rates will be in 10 years? Because home loans or large business loans are not short-term. And the borrower must have an idea, where the floating interest rate could be found and if it is in his interest to choose a fixed one.
Where will the interest rate be fixed?
Based on today’s data, Capital Economics calculates that the current rate cut cycle will take the Eurozone’s key rate to 2.5%, Britain’s to 3% and the US’s to 3.25% by the end of 2025. Some years of stability will follow, while long-term interest rates will rise again in the late 2020s and early 2030s.
Financial markets seem to agree, with US 10-year bond yields holding steady around 4% over the past year and German bond yields around 2.5%.
The fundamental forces that will push interest rates higher from 2029 to around 2035 are the following:
- Potential GDP growth will be boosted by a recovery in productivity growth as advances in artificial intelligence bear fruit. In fact, productivity growth in the US has already picked up strongly, to 2.9% annually in the first quarter.
- The boost from AI will partially offset the pressures from an aging population on GDP. At the same time as the proportion of over-65s in the population increases rapidly, total savings will likely decline. It is a factor that also pushes up the equilibrium interest rate, as more people will retire.
- And while desired savings will decrease, desired investment should increase. Both artificial intelligence and the green transition will play a role. Admittedly, another Trump presidency in the US would slow down the green transition, but it could well mean greater incentives and a more favorable tax framework for other types of investment.
By the mid-2030s, Capital Economics estimates that real interest rates in advanced economies will have risen slightly more to between 3% and 4%, with inflation held close to the 2% target.