The Scourge of Negative Real Interest Rates Continues
In a recent speech given at London School of Economics, Bank of England governor Andrew Bailey claimed credit for containing inflation in the past three decades (till COVID-19 Pandemic).
While boastful of central banks' inflation targeting approach for bringing down inflation to reasonable levels for three decades (at least till 2o21), he glossed over the fact that the major economies have been suffering from negative real interest rates.
In the UK, real interest rates have been negative since 2012. As can be seen in the graph below, they were always positive prior to 2012. The following chart gives a glimpse of the negative real interest rates in the UK >
Real interest rates are nominal interest rates adjusted for inflation. For example, the benchmark interest rate (Bank Rate) in the UK is 4.25 percent, whereas its consumer price inflation (CPI) is 10.40 percent, showing a negative real interest of 6.15 percent (=4.25 - 10.40).
In economies, savings are linked to investments. Unless a positive real interest rate exists, there is no incentive for savers to save. Without domestic savings, countries need to depend on foreign capital, which can be flighty and unpredictable at times.
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Most
major economies have negative real interest rates. As shown in table 1
below, among major economies, only Brazil and China are providing real
interest rates. The rest have negative real rates, which have been
continuing for several years.
Table 1: Showing Global Bond Yields, Interest Rates, Inflation Rates and Negative Real Interest Rates (data as of 31Mar2023) >
In the countries shown in above table, Turkey has been an outlier with a negative real interest rate of almost 47 percent. Even though consumer price inflation (CPI) rate has grown at a faster rate in the past 15 to 18 months, central banks (except a few) have not been raising interest rates in line with the rise in inflation rate.
The result is negative real rates as inflation has grown faster than the rise in benchmark interest rates.
Table 2: Showing how the CPI or consumer price inflation has moved between 15Dec2022 and 31Mar2023 >
In the past 15 weeks, inflationary pressures have come down, except in Switzerland, India and Australia -- where inflation has gone up by between 40 and 56 basis points (100 basis points equal one percentage point). This has led to surge in stock and crypto markets in the past three months.
Due to decline in inflation, markets are expecting a cut in interest rates in the second half of 2023. Another expectation in the market is the central banks would shift their focus to solving the liquidity problems in some US and European banks; and concentrate less on inflationary expectations.
I'm not sure about these things; however, it may be safe to assume the pace of interest rate hikes is behind us. The initial gains in inflation reduction are the easy part; the tougher part is to bring inflation further down, say from eight to less than six percent.
It may be easy for an obese person to lose weight by five to six percent in the initial stages, say, in the six to eight months window. But it's more arduous, if not impossible, for an overweight person to become normal -- once the initial gains are done. The same may be said of bringing down high inflationary trends.
To bring inflation further down, central banks may have to continue their tight monetary policy stance. Once they're done with rate hikes, they may have to keep the high rates longer to bring the inflation further down to less than three or four percent. As such, we can expect moderate rate hikes to continue while keeping the rates at elevated levels for some time, before they start cutting interest rates.
Table 3: Showing global bond yields and changes between between 15Dec2022 and 31Mar2023 >
In the past 15 weeks, there is slight uptick in 10-year sovereign bond yields in several nations as shown in table 3. Out of 15 major nations covered, ten have experienced rise in 10-year sovereign yield.
This looks counterintuitive when you look at some moderation in price rise (table 2 above). Maybe, the bond markets continue to be uncomfortable with the rate hikes being administered by the central banks (table 4 below).
Table 4: Showing benchmark policy interest rates and the changes between 15Dec2022 and 31Mar2023 >
What table 4 reveals is: in the past 15 weeks, ten out of 15 major nations continue with their rate hike path -- four nations experienced no rate hikes; while Turkey counterintuitively continues to reduce its benchmark rate even as inflationary pressures in Turkey remain at elevated levels.
The struggle for anchoring inflationary expectations continues.
Summing Up
Interest rate trajectory is hard to predict. What some of the major central banks, like, the Federal Reserve, the European Central Bank or Bank of England, will do in the next few quarters is anybody's guess.
Officially, the central banks say they're data dependent. Most of the major central banks may not be fully data dependent, though they officially proclaim so. They take cognisance of several things, like, what happens to political economy or war situations, like, the Russian invasion of Ukraine or others.
In the past decade, major central banks have failed to provide a positive real interest rate to savers. Global savings glut too has contributed to the plight of savers. There seems to be no end to the scourge of negative real rates in economies.
Whatever the central banks do, year 2023 is going to be an interesting year, after 2022 brought both stock and bond investors to their knees.
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Additional data from Trading Economics:
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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He blogs at:
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