Interest rates are falling, what’s next?

5
Interest rates are falling, what's next?
Interest rates are falling, what's next?

Africa-Press – Eritrea. The author is chief economic adviser and a board member at the London-based Centre for Economics and Business Research (CEBR).

We seem to be nearing the bottom of the rollercoaster. Inflation has dropped dramatically reflecting lower oil and gas prices as demand softened and the world switched from over reliance on Russian fossil fuel imports

ECB rate setters remain mindful of the period of deflation and economic stagnation, which was so hard to combat during the Eurozone crisis

The past few years have seen a rollercoaster ride in world interest rates. When COVID-19 hit in early 2020 and lockdowns were imposed by most governments, inflation disappeared from the system. Central bank interest rates dropped to practically zero to sustain the economy, accompanied by massive fiscal stimulus.

In the United Kingdom and Europe, and further afield, governments redirected substantial amounts of borrowed funds to companies to maintain payrolls, even for non-working employees, or offered direct support to households as happened in the United States. This was supported by central banks engaging in quantitative easing (QE), which involves buying government bonds in secondary debt markets to lower yields and make borrowing cheaper – a practice first used during the 2008-09 financial crisis. So far so good. The world economy rebounded strongly in 2021, with rock-bottom interest rates and widespread expectations that the inflation surge accompanying lifted lockdown restrictions would be temporary. Still, the Bank of England (BoE) was the first major central bank to tentatively raise rates by 15 basis points, to just 0.25% in December 2021, as inflation reached 5.4% that month.

But then came the Russian invasion of Ukraine in February 2022. All calculations went out of the window as energy and food prices rocketed. Central banks reacted to the inflation surge by raising rates, the US raised rates to a peak of 5.50%. Meanwhile, the UK increased rates in each of 14 consecutive meetings, reaching 5.25% by August 2023, to tame an inflation which peaked at 11.1%, the highest in 40 years. QE was reversed and replaced by quantitative tightening (QT), with central banks selling bonds into the market, withdrawing liquidity and pushing yields up. Large deficits and high debt quickly became unsustainable. The UK government’s costs of servicing its debt jumped from 1.4% pre-pandemic to 3.8% of GDP in 2022-23.

Nearing the bottom of the rollercoaster

It is possible to say that rates rose too fast. There is no doubt that they dampened world growth even though the reasons for the inflation surge were external supply issues, not excessive domestic demand. Not all countries of course were similarly affected with the US proving more resilient while Germany saw its economy shrink or stagnate in a number of quarters over the last couple of years. The UK economy grew by just 0.3% in 2023 and was more or less stagnant in the second half of 2024. China’s economy has also been suffering, partly reflecting weak demand for its exports. But at least now we seem to be nearing the bottom of the rollercoaster. Inflation has dropped dramatically reflecting lower oil and gas prices as demand softened and the world switched from overreliance on Russian fossil fuel imports to other energy sources, including LNG from the US and more renewables. Inflation came close to – and for a short time for some countries even below – the central banks’ 2% target, and interest rates have been, with some notable exceptions, on a downward path pretty much across the world. ​​​​​​​

Inflation risks on the horizon

There are plenty of upside inflation risks on the horizon. These risks include rising food prices, higher oil and gas prices exacerbated by further cuts in Russian gas flows to Europe, and President-elect Donald Trump’s proposed tariffs on all US imports. Latest inflation figures for the Eurozone showed an uptick to 2.9% in December. Yet the European Central Bank (ECB) is now ahead of the pack of other major central banks with its main deposit rate cut further to 3.0% last month, down from a peak of 4.5% in September 2023. And it could cut again in its late January meeting even as inflation rises. This is against the backdrop of continuing contraction in manufacturing though services are performing a bit better. Last year, the EU’s temporarily suspended stability and growth pact was reintroduced, albeit in a slightly milder form. This reintroduction signifies a return to fiscal retrenchment. Consequently, the case for ending a restrictive monetary stance to stimulate growth makes increasing sense.

In truth, the ECB rate setters remain mindful of the period of deflation and economic stagnation, which was so hard to combat during the Eurozone crisis. Repeating the same mistake would be costly, as the region seeks to promote investment and innovation to better compete with the US and China.

Source: Anadolu

For More News And Analysis About Eritrea Follow Africa-Press

LEAVE A REPLY

Please enter your comment!
Please enter your name here