Lower for longer? Outlook for global interest rates

Interest rates are pivotal in a world of high debt levels.

Higher US interest rates are signalling an end to the loose monetary policy of the past 10 years, but will other nations follow by lifting their rates?

Central banks are tiptoeing away from the money printer 10 long years after the 2008 global financial crisis (GFC).

However, while US economic growth has returned, the same can’t be said for other parts of the world, including Australia, where the environment of low interest rates, low growth, low inflation and low wages growth is expected to persist.

“The global financial crisis was tough because governments initially helped fight the process off with higher spending and lower taxes. Worried about budget deficits, central banks held interest rates close to zero,” says Deloitte Access Economics partner Chris Richardson.

Richardson acknowledges the various fiscal stimuli and monetary policy changes from governments globally prompted an initial recovery but says, in general, the world’s economy has been slow to repair.

“Ten years down the track it’s starting to change, but the key word is ‘start’,” he says. 

Global debt has increased, a natural reaction to historically low interest rates and the easy availability of cheap money. According to the Institute of International Finance, global debt reached US$247 trillion in the first quarter of 2018. This leaves the world economy in a vulnerable position should another credit crunch occur and lenders start calling in debts.

Divergent interest rate environment

Interest rates are pivotal in a world of high debt levels. While they have been rising in the US for years, this is not the case in Australia or Europe, where the benchmark refinancing rate is zero per cent.

In September 2018, the US Federal Reserve, which had been raising rates since December 2015, lifted its target interest rate 0.25 per cent to a range between 2.0 per cent and 2.25 per cent. The Reserve Bank of Australia’s (RBA) rate cycle is well behind the US, with Australia’s 1.5 per cent cash rate in place for more than two years.

“Select central banks have been removing very loose monetary policy post the financial crisis and the US is getting close to the neutral rate, where interest rates neither promote nor inhibit economic growth,” says Belinda Allen, senior economist, global markets, with Commonwealth Bank.

“It’s the interest rate to keep the economy just ticking along. We expect interest rates to rise in the US another three times between now and mid next year (2019). This will take rates to a peak of between 2.75 per cent and 3.0 per cent, which is low compared to history, but a long way from zero, which is where we got to post-GFC,” she adds.

Where to from here?

Allen says the interest rate dynamic is prompting markets to ponder the question, ‘Where to from here?’. The lower Australian dollar, driven down by high US rates stimulating the greenback, is another variable. A depressed Australian currency lifts demand for commodities, which is positive for the Australian economy.

Australian economic growth of 3.4 per cent is well above trend growth of 2.75 per cent. This rate of growth, however, isn’t providing a kick start to other drivers.

“In Australia, stronger production growth is generating very little in terms of higher prices and higher wages. So, we have to let the economy run a little bit hotter to remove some slack to generate higher wages,” Allen adds.

That is different from the US, where there has already been some wages growth. Unemployment in the US is 3.7 per cent, lower than the natural rate of 4.5 per cent.

“Our unemployment rate has fallen to 5.3 per cent, but our natural rate is about 5 per cent. That’s why we’re generating very little in the form of wages growth and why the RBA will be on hold for longer here,” she says.

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Prices and inflation remain flat

Weak wages growth also leads to low inflation, with prices even stagnant in some countries, says Sarah Hunter, head of Australia macroeconomics at research house BIS Oxford Economics. She believes local rates will remain where they are until June 2020.

“We’ve had employment growth but we haven’t seen wages growth, and in Australia that trend is set to continue.”

Hunter explains that internationally it has taken time for labour markets to reach a point where capacity has prompted wage increases. It’s only in the US and Germany where this has been the case so far since the financial crisis. 

In Australia, it will take some time for wage and price inflation to occur and, as a result, Hunter doesn’t expect the RBA to lift the cash rate until the June quarter of 2020.

US tariff increases

In terms of the outlook for global markets, there is some uncertainty about the impact of the US’s latest round of tariffs.

“This is going to give an inflationary boost through the system because a number of consumer goods are now subject to tariffs, and will start to go up in price, which will increase the pace of headline inflation,” says Hunter.

Household debt has been falling in the US and Europe, with higher savings rates than before the financial crisis. Australia is an exception, where debt levels have risen sharply due to the housing boom, says Hunter.

“The countries in this position are like Australia and are relatively small, for instance Canada to some extent, Sweden and Hong Kong. So, broadly speaking, we’re not concerned,” she says.

Although there are some risks to the global economy with the US changing global trade rules, experts anticipate further economic growth.

Read next: Australia’s big appetite for consumer debt

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October 2021
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