The Global Struggle with Interest Rates
The world was once enjoying a decade-long spree of ultra-low interest rates. Now, we have to adapt to the highest interest rates in recent history.
Since the 2008 financial crisis, interest rates around the globe have been close to zero. Central banks were focused on getting their economies back on track. This worked as the US, the UK and the EU saw stable GDP growth for 10 years, and businesses and investors became accustomed to the low borrowing costs.
However, when the COVID-19 pandemic hit, almost every country went into an economic recession. Supply chains were cut, consumer spending shrunk, and the world was on a halt. The breaks were slammed when business was booming at high speeds. By the end of the pandemic, the past 10 years of work was undone.
So as soon as things started opening up, people were desperate to spend, borrow and invest. Global demand skyrocketed while supply chains were still recovering from disruptions, pushing prices up. A main contributor was China, which took longer to ease COVID-19 restrictions and thus could not adapt to global demand for their exports. Then, there was the Russia-Ukraine war and the Russian sanctions. This cut off the supply of grain from Ukraine and oil from Russia, causing a global food and energy crisis. Other factors include labour shortages and quantitative easing. Western economies were facing extreme inflationary pressures, and they turned to monetary policy to fix this.
Central banks around the world have been progressively raising interest rates to curb inflation since the start of 2022. This had a major effect on companies that took on large loans to get business back on track. This, coupled with high inflation and a cash flow crisis, many companies around the world were facing threats of insolvency. Clear examples of collapsed businesses were the American Silicon Valley Bank, large investment bank Credit Swiss and the British retail chain Wilko. Despite the overwhelming urge to bounce back from the pandemic, most businesses were forced to take on a risk-averse approach to their investments, as borrowing costs continued to rise.
In the past few months, the Western economies appear to have stabilised. Currently, the Federal Reserve (Fed), Bank of England (BoE) and the European Central Bank (ECB) are holding their benchmark interest rates at 5.25%, 5.25% and 4.5% respectively. Though this has been working to tame inflation, so far only the Fed has announced that they will be cutting rates in 2024.
This has put businesses and investors on the edge of their seats. Everyone is itching to operate their businesses just like they used to as soon as interest rates drop. But can we realistically operate like we did in the pre-pandemic days?
We may have to come to terms with the fact that interest rates may never be as low as they were in the 2010s, or at least not in the near future. Neither the US, the UK or the EU are near its 2% inflation target. Inflation rates in the UK and EU are forecasted to only reach 2% in 2025. Average wages continue to rise in all 3 regions, making central banks hesitant to cut rates. The ECB also cited “wars and conflict” as concern for potential inflationary pressures. EU suppliers remain hesitant to do business with the UK, showing that the British are still struggling with the effects of Brexit. With China facing a property crisis and an economic slowdown, supply chains to the US continue to be disrupted.
But the effects of the pandemic may not have been all gloomy. Countries have realised how vulnerable they are from supply chain disruptions. In response, there is a growing trend for companies to diversify and shift their supply chains, such as the “China plus one” business strategy. This gives other developing countries a chance to shine. India is a prime example of this, with large corporations such as Apple and Tesla already beginning to shift their resources from China to India. The country’s stock exchange market cap is expected to surpass Hong Kong’s, as Indian companies continue to deleverage, paying off debts and issuing equity.
Other companies around the globe are moving to re-onshore functions. Biden’s Inflation Reduction Act reinforces this by pumping billions of investments into domestic developments to support this movement, with the aim to revitalise America’s manufacturing industry, providing jobs and strengthening supply chains. A large portion of these investments are also being directed to renewable energy.
Some call this movement “deglobalisation”, others call it a defensive mechanism which adds to the already-high geopolitical tensions between the US and China. I believe that we are currently living in a turning point in history — the world is only beginning to adapt to this new macroeconomic environment.
