Will Interest Rates Stay Low Forever?
For the past decade, interest rates around the world have remained at all-time lows and show no sign of recovering.
During times of uncertainty and lack of consumer confidence within an economy, they tend to fall. This was apparent during the global financial crisis of 2007–2008, when the UK Base Rate fell to its lowest level for 300 years. In July 2007 it stood at 5.75%, but fewer than 2 years later rates had fallen to 0.5%. Since then, they have struggled to rebound, and the recent coronavirus outbreak has even sent some interest rates below zero. In the future, could we see them steadily rise again, or will they become a new normal in our modern economy?
Central banks, such as the Bank of England, lower the interest rate so that the government can support their economy in different ways. The BoE’s Monetary Policy Committee decide on the base rate 8 times per year, in accordance to the economic temperament and situation of the UK economy.
One consequence of lowering interest rates is that governments have access to cheap debt in order to support the country during times of hardship. The coronavirus in particular, will cost the UK government an estimated £394 billion for the current financial year. This has been spent on measures such as the furlough scheme, NHS funding, and to fill in the deficit caused by smaller tax revenues throughout the year. This year the Bank of England alone is buying £450bn worth of government bonds (UK gilts) in order to help fund these policies, which would be more costly if interest rates were higher.
The global financial crisis itself was caused by low interest. Despite times of low unemployment and stable inflation within the US economy during the early- to mid-2000s, interest rates were relatively low. This meant that subprime borrowers were able to get loans to buy homes, which otherwise would not be possible due to their poor credit history or financial stability. the subprime mortgage market grew and grew, until it was met by increases in the interest rates which thus increased the monthly payments of the mortgages. This resulted in a flurry of homeowners defaulting on their loans and losing their homes with it. As a result, the housing market crashed and America, along with the rest of the world, plunged into deep recession.
Thus, there may be a risk that today’s interest rates, far lower than those seen leading up to the crisis, may mean that borrowers become over-leveraged and unable to pay off their debts. This is unlikely however, as regulation on subprime lending and caution shown by banks have been put in place to deter this from happening again.
The question is now, will they ever rise again, or will near-zero interest rates become normality? The truth is no one knows. In modern day society, it is impossible to predict what the economy will do in the future, and anyone who tells you they can is lying to you. There are no way events such as the coronavirus pandemic could have been predicted by economists years ago, which subsequently collapsed interest rates even further. If in the future, inflation begins to pick up again and exceed the 2% target set by the UK government, then the Base Rate is likely to be increased to try and prevent any further inflation in the economy. However, we do not know what the future entails and whether consumer confidence will begin to rise as we move out of the pandemic.
A report by the International Center for Monetary and Banking Studies states:
“Market participants presently appear to believe that current conditions are likely to persist for many years, though our analysis leads us to think that rates should gradually recover from their present very low levels. Our discussion also considers how government policy choices could affect that path.”
This reveals that even the experts doubt that interest rates will rise in the short- to mid-term future.
Furthermore, it was written in 2015 when the UK base rate was around 1%. Since then, it has fallen further due to the recent pandemic, and now floats just above zero. Therefore, any sort of recovery has been postponed even further into the future and will therefore last longer. Noticeably, it states that government choices will significantly affect the recovery, so we could see different prospects for different countries worldwide depending on how they handle recovering from the effects of the virus. It will be interesting to see the different strategies and which work, and which don’t.
In my opinion, I have optimistic hopes for a strong rebound from these unprecedented times. However, the way the government chooses to raise funds to pay off all the debt they have borrowed will be crucial in determining whether the economy will flourish. They must get the balance right between encouraging consumption and demand for goods and services within the economy, while ensuring they raise enough capital to finance these huge debts. The next few years will be tough, but I have high hopes that the recovery will be strong, and, in the future, we could see small, incremental rises in interest rates, assuming no more unexpected events occur.
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Ted Jeffery
