As we find ourselves heading into the second decade of the credit crunch era we find ourselves observing an interest-rate environment that few expected when it began. At the time the interest-rate cuts ( for example circa 4% in the UK) were considered extraordinary but the Ivory Towers would have been confident. After all they had been busy telling us that the lower bound for interest-rates was 0% and many were nearly there. Sadly for the Ivory Towers the walls then came tumbling down as Denmark, the Euro area , Sweden, Switzerland and Japan all entered the world of negative official interest-rates.

Even that was not enough for some and central banks also entered into sovereign and then other bond purchases to basically reduce the other interest-rates or yields they could find. Such QE ( Quantitative Easing) purchases reduced sovereign bond yields and debt costs which made politicians very happy especially when they like some official interest-rates went negative. When that did not work either we saw what became called credit easing where direct efforts went into reducing specific interest-rates, In the UK this was called the Funding for Lending Scheme which was supposed to reduce the cost of business lending but somehow found that  instead in the manner of the Infinite Improbability Drive in the Hitchhikers Guide to the Galaxy  it reduced mortgage interest-rates initially by around 1% when I checked them and later the Bank of England claimed that some fell by 2%.

What next?

Yesterday brought a reminder that not everywhere is like this so let me hand you over to the Reserve Bank of India.

On the basis of an assessment of the current and evolving macroeconomic situation at its
meeting today, the Monetary Policy Committee (MPC) decided to:
• increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis
points to 6.25 per cent.
Consequently, the reverse repo rate under the LAF stands adjusted to 6.0 per cent, and the
marginal standing facility (MSF) rate and the Bank Rate to 6.50 per cent.

There are two clear differences with life in Europe and the first is a rise in interest-rates with the second being that interest-rates are at or above 6% in India. It feels like another universe rather than being on the sub-continent but it does cover some 1.3 billion people. Sometimes we over emphasise the importance of Europe. As to why it raised interest-rates the RBI feels that the economy is going well and that inflation expectations are rising as domestic inflation ( official rents) has risen as well as the oil price.

The US

This has moved away from zero interest-rates and now we face this.

to maintain the federal funds rate in a target range of
1½ to 1¾ percent

It seems set to raise interest-rates again next week by another 0.25% which has provoked Reuters to tell us this.

With inflation still tame, policymakers are aiming for a “neutral” rate that neither slows nor speeds economic growth. But estimates of neutral are imprecise, and as interest rates top inflation and enter positive “real” territory, analysts feel the Fed is at higher risk of going too far and actually crimping the recovery.

Personally I think that they do not understand real interest-rates which are forwards looking. So rather than last months print you should look forwards and if you do then there are factors which look likely to drive it higher. The most obvious is the price of crude oil which if we look at the West Texas Intermediate benchmark is at US $65 per barrel around 35% higher than a year ago. But last month housing or what the US callers shelter inflation was strong too so there seems to be upwards pressure that might make you use more like 2.5% as your inflation forecast for real interest-rates. So on that basis there is scope for several more 0.25% rises before real interest-rates become positive.

One point to make clear is that the US has two different measures of inflation you might use. I have used the one that has the widest publicity or CPI Urban ( yep if you live in the country you get ignored…) but the US Federal Reserve uses one based on Personal Consumption Expenditures or PCE. The latter does not have a fixed relationship with the former but it usually around 0.4% lower. Please do not shoot the piano player as Elton John reminded us.

If we move to bond yields the picture is a little different. The ten-year seems to have settled around 3% or so ( 2.99% as I type this) giving us an estimated cap for official interest-rates. Of course the picture is made more complex by the advent of Quantitative Tightening albeit it is so far on a relatively minor scale.

The Euro area

Here we are finding that the official line has changed as we await next week’s ECB meeting. From Reuters.

Money market investors are now pricing in a roughly 90 percent chance that the European Central Bank will raise interest rates in July 2019, following hawkish comments from the bank’s chief economist on Wednesday.

In terms of language markets are responding to this from Peter Praet yesterday.

Signals showing the convergence of inflation towards our aim have been improving, and both the underlying strength in the euro area economy and the fact that such strength is increasingly affecting wage formation supports our confidence that inflation will reach a level of below, but close to, 2% over the medium term.

For newer readers he is saying that in ECB terms nirvana is near and so it will then reduce policy accommodation which is taken to mean ending monthly QE and then after a delay raising interest-rates.

So it could be a present from Mario Draghi to his successor or of course if he fails to find the switch a job he could pass on without ever raising interest-rates in his eight years as President.

Comment

Before I give my opinion let me give you a deeper perspective on what has been in some cases all in others some of our lives.

Since 1980, long-term interest rates have declined by about 860 basis points in the United States, 790 basis points in Germany and more than 1,200 basis points in France. ( Peter Praet yesterday)

On this scale even the interest-rate rises likely in the United States seem rather small potatoes. But to answer the question in my title I am expecting them to reach 2% and probably pass it. Once we move to Europe the picture gets more complex as I note this from the speech of Peter Praet.

the underlying strength in the euro area economy

This is not what it was as we observe the 0.4% quarterly growth rate in Euro area GDP confirmed this morning or the monthly and annual fall in manufacturing orders for Germany in April. Looking ahead we know that narrow money growth has also been weakening. Thus the forecasts for an interest-rate rise next June seem to be a bit like the ones for the UK this May to me.

Looking at the UK I expect that whilst Mark Carney is Bank of England Governor we will be always expecting rises which turn out to be a mirage. Unless of course something happens to force his hand.

On a longer perspective I do think the winds of change are blowing in favour of higher interest-rates but it will take time as central bankers have really over committed the other way and are terrified of raising and then seeing an economic slow down. That would run the risk of looking like an Emperor or Empress with no clothes.