Thursday, 13 September 2012

Time past, time present and time future…

An article appeared in the Financial Times this week which looked at the current interest rate environment from an historical perspective, citing the market historian Jim Reid. It revealed some fascinating data. By way of example, the Netherlands, which has data stretching back into the mists of time, saw its bond yields hit a 495 year low in June this year. For those with an historic bent, this was the same year that Martin Luther published his 95 Theses denouncing the sale of indulgences by the Catholic Church, widely regarded as the catalyst for the Protestant Reformation. UK base rates are at their lowest levels in 318 years, the year the Bank of England was founded. From any perspective, these are considerably long periods.

Surely, then, there is only one way interest rates can go from here, right? Well, probably, but not necessarily and almost certainly not in the short term. Indeed, there is still a little scope for interest rates to fall further, although any effect would be more symbolic than anything else. The economic environment – one of extremely sluggish growth, relatively subdued “demand pull” inflation (although not, unfortunately, “cost push” inflation) and little wage inflation – make Central Bankers likely to keep their interest rate policies as accommodative as possible. Moreover, quantitative easing strategies adopted by Central Banks are likely to keep longer term interest rates at these historically low levels, provided, of course, that markets feel that sovereign solvency is not in doubt. This is doubly useful, of course, when one has a large budget deficit to finance. That said,  in their quest to avoid deflation, Central Bankers would be only too delighted to be in a position where they had to raise rates as it would, at least, signal that economies were finally beginning to respond the various strategies adopted to stimulate growth.

And herein lies the problem. At some stage, interest rates will need to move back to more historical “normal” levels (whatever that means) and an economy that has become used to interest rates at such low levels may find any transition painful as, indeed, would a raft of other asset classes. This is, however, likely to be a problem of the future rather than one of the present as, to my mind, the current environment is likely to persist for some time to come.

Rob Burgeman
Divisional Director

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