ONE of the more interesting debates and uncertainties in relation to the hopefully approaching post-pandemic world is the future path of interest rates and inflation.
As the pandemic hit back in March 2020, central bankers moved aggressively with interest rates and quantitative easing to inject as much monetary policy stimulus as possible into the global economy. At the same time, governments almost everywhere applied aggressive fiscal policy stimulus through a combination of tax cuts and expenditure increases to varying degrees.
The objective was to reignite economic activity and get some much-needed inflation back into the system.
What is particularly interesting is that central banks were basically just continuing the approach adopted by policymakers since the great financial crash over a decade ago. The battle for central bankers has been to fight falling prices and generate much-needed upward price momentum.
Back in 2018, I incorrectly posited the notion at a credit union conference that central bankers might start to talk about higher interest rates late, in 2019, and start to deliver same in a gradual and limited fashion from 2020 onwards. As always, I caveated this projection with the usual warnings about the danger and futility of economic forecasting.
I also expressed the view that I really hoped I would be proved correct, because rising interest rates would signify stronger economic growth and building price pressures, and a continuation of low rates would signify economic weakness.
In the event, this did not turn out to be the case and, while some of this can charitably be attributed to the shock of the pandemic, the reality is that global growth in 2019 was quite anaemic, and inflation was still undershooting targeted levels by a significant margin in most jurisdictions. Hence, a continuation of very low interest rates was still the most appropriate policy stance.
Of course, the pandemic just exacerbated these deflationary pressures and interest rate response.
So, we are currently stuck in an environment of rock-bottom official interest rates and bond yields that are very close to historic lows.
This short- and long-term interest rate environment is a sign of economic weakness and nothing more. The problem of course here in Ireland and elsewhere is that the artificially low interest rate environment continues to fuel house price inflation which is no good for anybody, particularly the younger generation that is struggling to get a foot on the housing ladder.
We need economic growth to pick up strongly and for central bankers to have to respond with higher interest rates. Rising rates would be a sign of stronger economic growth and some much-need inflation in the system. Unfortunately, the prospect of higher interest rates does not appear likely.
Last week the US Federal Reserve’s interest rate-setting committee, the FOMC, expressed the view that although economic growth is picking up as the economy continues to recover, there is still a requirement for current low interest rates and ongoing bond buying for the foreseeable future.
Although inflation is well above its desired 2% target, this spike is believed to be transitory and will not necessitate any increase in interest rates soon. Indeed, US economic growth in the second quarter at 6.5% annualised is softer than expected, and will just reinforce the Federal Reserve’s view that interest rates will need to remain low.
In Europe, the same analysis can be applied, albeit the recovery in the eurozone is less vibrant than in the US.
While the Bundesbank president Jens Weidmann has expressed concerns that the ECB might keep interest rates too low for too long, there is no danger that the ECB will be swayed any time soon from its very expansionary approach.
Unfortunately, a continuation of the ultra-low interest rate environment will continue to fuel house price inflation here, which is not an economically or socially desirable prospect.
As perverse as it might seem, a sustainable housing market needs higher interest rates, and the sooner the better. Of some limited solace for the housing market is the fact that new dwelling completions in the second quarter were up strongly.