tag:theconversation.com,2011:/au/topics/interest-rates-1102/articlesInterest rates – The Conversation2024-03-14T17:19:18Ztag:theconversation.com,2011:article/2245742024-03-14T17:19:18Z2024-03-14T17:19:18ZBuying your first home? Here’s how to increase your chances of getting a mortgage<figure><img src="https://images.theconversation.com/files/580959/original/file-20240311-16-tn9hxt.jpg?ixlib=rb-1.1.0&rect=56%2C56%2C3342%2C2414&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/mortgage-concept-by-money-house-coins-278179301">Denphumi/Shutterstock</a></span></figcaption></figure><p>Applying for a mortgage for the first time can be a daunting task. But there are several ways you can increase your chances of having your application accepted.</p>
<p>The outcome of a mortgage application largely depends on your deposit size, ability to repay and credit score. These are the factors that make you more or less risky in the eyes of the lender.</p>
<p>As a first step, it is important that you improve your understanding of <a href="https://www.money.co.uk/mortgages/a-complete-guide-to-mortgages">what a mortgage is</a> and how the <a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">repayments work</a>. </p>
<p>But make sure you are also familiar with a <a href="https://www.moneyhelper.org.uk/en/homes/buying-a-home/mortgage-affordability-calculator">mortgage calculator</a> to see what you can afford. Mortgage calculators are tools that give you an estimate of how much you could borrow from a lender or what your monthly repayments and other costs might be.</p>
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<img alt="Quarter life, a series by The Conversation" src="https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/451343/original/file-20220310-13-1bj6csd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><em><strong><a href="https://theconversation.com/uk/topics/quarter-life-117947?utm_source=TCUK&utm_medium=linkback&utm_campaign=UK+YP2022&utm_content=InArticleTop">This article is part of Quarter Life</a></strong>, a series about issues affecting those of us in our 20s and 30s. From the challenges of beginning a career and taking care of our mental health, to the excitement of starting a family, adopting a pet or just making friends as an adult. The articles in this series explore the questions and bring answers as we navigate this turbulent period of life.</em></p>
<p><em>You may be interested in:</em></p>
<p><em><a href="https://theconversation.com/if-you-get-your-financial-advice-on-social-media-watch-out-for-misinformation-222196">If you get your financial advice on social media, watch out for misinformation
</a></em></p>
<p><em><a href="https://theconversation.com/future-graduates-will-pay-more-in-student-loan-repayments-and-the-poorest-will-be-worst-affected-222840">Future graduates will pay more in student loan repayments – and the poorest will be worst affected</a></em></p>
<p><em><a href="https://theconversation.com/four-environmental-red-flags-to-watch-out-for-when-buying-your-new-home-215763">Four environmental red flags to watch out for when buying your new home</a></em></p>
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<h2>Try not to stretch your budget to the limit</h2>
<p>Typically, you are allowed to borrow four-and-a-half times your annual income from a mortgage lender. So, for a 30-year old earning an annual salary of <a href="https://www.forbes.com/uk/advisor/business/average-uk-salary-by-age/">£32,000</a>, the top limit will be £144,000. Two people with the same salary would be able to borrow £288,000 for a house they are buying together.</p>
<p>Next, decide whether you want to stretch your budget to its limit. The higher the value of the home you are buying, the bigger the mortgage repayment you will have to make. Not stretching your budget may help increase your chances of getting a mortgage.</p>
<p>This is because lenders consider your other outgoings, such as utility bills, council tax, childcare or other debt payments, when evaluating your application. Having an income buffer makes your mortgage application less risky for the lender as you will have more ability to repay.</p>
<p>Allowing yourself a buffer will also offer you at least some insurance against a future blip to your income, and help manage the UK’s current <a href="https://www.instituteforgovernment.org.uk/explainer/cost-living-crisis">cost of living crisis</a>. Household incomes are not keeping up with living costs and are not expected to return to 2021 levels until 2027.</p>
<h2>Improve your credit score</h2>
<p>A <a href="https://www.moneysavingexpert.com/credit-cards/what-is-a-good-credit-score/">credit score</a> shows mortgage lenders that you have managed money well and responsibly in the past. A higher credit score makes you a less risky investment for them. Various <a href="https://www.experian.co.uk/experian-account/01_free_score.html?awc=7716_1709563137_ace0ba76c949f233521c2af44416b28e">credit reference agencies</a> allow you to check your credit score for free.</p>
<p>You can protect your credit score in a number of ways. Holding one bank account for a long time is helpful but your borrowing history also matters. </p>
<p>Being close to your credit limit may lower your score. However, not having any debt at all in the past may also make it difficult for mortgage lenders to judge whether you are a responsible borrower. So a good balance is needed.</p>
<p>Missing regular payments for bills or debt will certainly dent your credit score. And be aware that if you have joint bank accounts with others, their poor credit score may also impact yours.</p>
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<img alt="An approved mortgage loan application with a house-shaped keyring." src="https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/580961/original/file-20240311-20-mal1md.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">There are several ways you can increase your chances of having your application accepted.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/approved-mortgage-loan-agreement-application-house-355901639">Fabio Balbi/Shutterstock</a></span>
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<h2>Save a larger deposit</h2>
<p>The risk for lenders is lower when borrowers have a large deposit in comparison to the value of the home they are buying. Lenders also charge lower interest rates on mortgage repayments when you have more of a deposit.</p>
<p>A 10% deposit is often the norm, and the rest can be borrowed from the lender. However, there are also opportunities to buy a home with <a href="https://www.ownyourhome.gov.uk/scheme/mortgage-guarantee-scheme/">only a 5% deposit</a> for first-time-buyers. </p>
<p>This type of mortgage may increase your chances of buying a home if you cannot save for a larger deposit. But be aware that lenders charge <a href="https://www.moneysavingexpert.com/mortgages/new-mortgage-scheme-for-5-deposit/">higher interest rates</a> for low-deposit mortgages as the risk is higher for them.</p>
<p>So-called <a href="https://www.skipton.co.uk/mortgages/track-record-mortgage">rental track record</a> mortgages even allow you to buy with no deposit. If you are renting at the moment and are planning to apply for a rental track record mortgage, then make sure you pay your rent on time for at least 12 months beforehand to be eligible.</p>
<p>However, it is important to be aware that smaller deposits mean a greater risk of you ending up with negative equity if house prices drop. <a href="https://www.moneyhelper.org.uk/en/homes/buying-a-home/negative-equity-what-it-means-and-what-you-can-do-about-it">Negative equity</a> is a situation where the value of your home ends up lower than the remaining value of your mortgage.</p>
<h2>Borrow for longer</h2>
<p>Currently, 55% of first-time buyers have a mortgage term of <a href="https://www.ukfinance.org.uk/system/files/2023-03/Household%20Finance%20Review%202022%20Q4.pdf">longer than 30 years</a>. Mortgages that last as long as <a href="https://www.ftadviser.com/mortgages/2019/06/26/most-mortgages-now-have-40-year-terms/?utm_campaign=FTAdviser+news&utm_source=emailCampaign&utm_medium=email&utm_content=">40 years</a> are also on the rise.</p>
<p>The longer the mortgage term, the lower your monthly repayments are likely to be as they are stretched over a longer period. This increases your ability to afford the monthly payments so again reduces the risk for lenders.</p>
<p>However, longer mortgages mean paying interest charges for a longer period, so they cost much more over time. For a £288,000 mortgage with a 5% interest rate, for example, you would make a staggering £161,653 in additional interest payments if you borrow for 40 years instead of 25. Check other scenarios <a href="https://www.moneysavingexpert.com/mortgages/mortgage-rate-calculator/">here</a>.</p>
<p>With many mortgage products you can make an over payment of 10% per year. Thus, another option would be to keep your monthly payments low and make bulk payments whenever you have extra savings. This will help you to reduce the duration of the mortgage.</p>
<p>This may not be ideal for everyone. However, buying jointly with family and friends could help strengthen your repayment capacity and credit scores. You should, of course, seek independent legal advice over the risks involved before doing so.</p><img src="https://counter.theconversation.com/content/224574/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Simple tips to improve your chances of having your mortgage application accepted.Alper Kara, Professor of Banking and Finance, Brunel University LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2240602024-03-06T19:15:33Z2024-03-06T19:15:33ZInterest rates are expected to drop but trying to out-think the market won’t guarantee getting a good deal<p><em>This article is part of The Conversation’s series examining the housing crisis. Read the other articles in the series <a href="https://theconversation.com/au/topics/housing-series-2024-153769">here</a>.</em></p>
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<p>With most economists expecting interest rates to start falling later this year, prospective home buyers might be weighing up whether to buy now for fear of strong competition for stock, or waiting until repayments are lower.</p>
<p>The financial markets and private sector economists expect the Reserve Bank to start cutting interest rates later this year. But the average forecaster is expecting just one cut in the next 12 months, of 0.25%.</p>
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<p>While rates have risen 13 times since May 2022, the drop won’t be so far nor so fast.</p>
<p>Even by the end of 2026 rates will probably only be around 1% lower than now.</p>
<p>And this may be as low as interest rates go. The interest rates we saw during the COVID recession were arguably the <a href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/stuck.pdf">lowest in human history</a>. </p>
<p>We are highly unlikely to return to these lows.</p>
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<img alt="Graph of interest rates dating back to 1575, going down since 1975" src="https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=277&fit=crop&dpr=1 600w, https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=277&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=277&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=348&fit=crop&dpr=1 754w, https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=348&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/578495/original/file-20240228-18-jx645r.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=348&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/stuck.pdf">Bank of England</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
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<h2>Neutral interest rates</h2>
<p>In normal times, we would expect interest rates to be higher than inflation. People can reasonably expect to be compensated for delaying spending. The margin by which interest rates exceed inflation in the medium-term is known as the <a href="https://www.rba.gov.au/speeches/2022/sp-ag-2022-10-12.html">neutral real rate of interest</a>. </p>
<p>This Goldilocks rate would apply when the Reserve Bank is neither trying to squeeze inflation nor stimulate demand. </p>
<p>The Reserve has used <a href="https://www.rba.gov.au/speeches/2022/sp-ag-2022-10-12.html">nine different approaches</a> to estimate this neutral real rate. The average result is that it may have dropped from around 3% in the 1990s to around 1% in the 2020s.</p>
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<p>This is also around the <a href="https://www.bis.org/publ/qtrpdf/r_qt2403b.htm">average value estimated in comparable countries</a>. In these days of global financial markets, it could be expected that there would be similar trends across countries. The decline in the global neutral real rate may be due to a <a href="https://www.brookings.edu/articles/the-hutchins-center-explains-the-neutral-rate-of-interest/">reduction in the global economic growth rate associated with population ageing and higher global savings</a>.</p>
<p>The Reserve Bank aims for inflation to average around the midpoint of its <a href="https://www.rba.gov.au/education/resources/explainers/australias-inflation-target.html">2-3% target range</a>. So if the neutral real rate is around 1%, this would imply that the Reserve’s <a href="https://www.rba.gov.au/statistics/cash-rate/">cash rate</a> (at which banks lend to each other overnight) would be around 3.5%.</p>
<p>This is about what the forecasters are expecting by the end of 2026.</p>
<p>Commercial banks <a href="https://www.rba.gov.au/education/resources/explainers/banks-funding-costs-and-lending-rates.html">set the interest rates</a> they charge on their loans by adding a margin to the Reserve Bank’s cash rate.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/the-help-to-buy-scheme-will-help-but-wont-solve-the-housing-crisis-224956">The Help to Buy scheme will help but won't solve the housing crisis</a>
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<p>They set the interest they pay on deposits by subtracting a margin from the cash rate. The difference between the two (and any fee income) meets the costs of running the bank such as wages and premises, allows for some loans not being repaid and provides some profits. The margins will be smaller if the banking market is very competitive.</p>
<p>Banks generally move their mortgage interest rates in line with the cash rate. If by the end of 2026 the cash rate is 1% lower, it is likely home loan interest rates will also be around 1% lower. This would reduce the monthly repayment on a 30-year loan for $1 million by $700.</p>
<h2>The impact of (somewhat) lower interest rates on house prices</h2>
<p>If the housing market is reasonably efficient, these broadly expected decreases in interest rates should largely be already “priced in” by investors. This would suggest relatively little impact as the expected cuts materialise.</p>
<p>But some potential homebuyers will be able to borrow more once interest rates drop. And many of them will choose to do so. They may then bid house prices up.</p>
<p>This is why <a href="https://theconversation.com/mortgage-and-inflation-pain-to-ease-but-only-slowly-how-31-top-economists-see-2024-218927">most economists are forecasting house prices to rise further</a> during 2024. The average expected increase is 5% in Sydney and 3% in Melbourne. </p>
<p>The increases are comparable to the expected rises in incomes so affordability will not significantly worsen. But buying a home will not be getting any easier.</p>
<p>A similar pattern of expected easing interest rates leading to higher house prices is being observed <a href="https://www.ft.com/content/b6d89def-aea4-4790-9ff5-cddf32f3b36c">around the world</a>.</p>
<p>Renters may be hoping landlords will pass on interest rate decreases to them. But they are likely to be disappointed. Rents have risen not due to interest rate rises but because the vacancy rate is low. With strong population growth, this is unlikely to change soon.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/urbanisation-and-tax-have-driven-the-housing-crisis-its-hard-to-see-a-way-back-but-covid-provides-an-important-lesson-223548">Urbanisation and tax have driven the housing crisis. It's hard to see a way back but COVID provides an important lesson</a>
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<h2>What to do?</h2>
<p>Trying to out-think the market is unlikely to work.</p>
<p>Not buying your dream home and instead waiting for a drop in interest rates may be a mistake. But so might panic-buying something that’s not what you want out of fear of further rises in house prices.</p><img src="https://counter.theconversation.com/content/224060/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Hawkins was formerly a senior economist at the Reserve Bank and the Australian Treasury and was secretary to the Senate Select Committee on Housing Affordability in Australia in 2008.</span></em></p><p class="fine-print"><em><span>Craig Applegate does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Despite different theories, there is no simple answer to whether prospective home buyers are better off buying before or after the expected interest rate drop in the next year.John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of CanberraCraig Applegate, Assistant Professor, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2242202024-02-25T14:20:26Z2024-02-25T14:20:26ZHere’s what we can learn from Canada’s response to inflation in the 1980s and 1990s<p>For the last two years, inflation has been at top of mind for Canadians. It is a tax on households. When prices rise, <a href="https://www.bankofcanada.ca/2020/08/understanding-inflation">the purchasing power of each dollar earned falls</a>.</p>
<p>This generates huge losses for the economy, as well as households on fixed incomes, and increases uncertainty, making it more difficult to plan for the future.</p>
<p>The real question in the minds of many economists is what the trend in inflation will be going forward, and when interest rates will begin to fall and bring relief to Canadians.</p>
<p>While this episode of inflation has created challenges for many, this is not the first time Canada has gone through such an experience; we have been here before.</p>
<h2>Inflation in the 1980s and 1990s</h2>
<p>Canada faced a serious inflation problem in the 1980s and 1990s when the consumer price inflation (CPI) index hit <a href="https://economics.td.com/ca-inflation-new-vintage">13 per cent in 1980 and was still at seven per cent in 1991</a>. </p>
<p>To solve this issue, in 1991, the Bank of Canada and the Minister of Finance agreed on a plan <a href="https://www.bankofcanada.ca/core-functions/monetary-policy/agreement-inflation-control-target/">to bring inflation down to a target level</a>. Initially, this was six per cent, but this was lowered to two per cent (within a one to three per cent range).</p>
<p>The Bank of Canada <a href="https://www.bankofcanada.ca/2022/04/understanding-policy-interest-rate">uses the overnight rate to control inflation</a>. This rate determines the rates of government treasury bills, the bank rate and variable rate mortgages. </p>
<p>In August 1981, <a href="https://www.huffpost.com/archive/ca/entry/high-interest-rates-canada-economy_ca_5fe4d080c5b66809cb30a445">the Bank of Canada pushed this rate to well over 20 per cent</a> — equivalent to a variable rate mortgage cost today of almost 23 per cent. In May 1990, the central bank increased the rate to almost 14 per cent. In both cases, the central bank brought inflation down, <a href="https://www.thecanadianencyclopedia.ca/en/article/recession">but at the cost of a serious economic slowdown</a>. </p>
<h2>The pandemic fuelled inflation</h2>
<p>The <a href="https://www.reuters.com/markets/us/canada-expected-renew-policy-framework-amid-concerns-about-rising-inflation-2021-12-13">inflation target was most recently renewed in December 2021</a>. It was remarkably effective until summer 2021, when inflation exceeded the three per cent range and <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/220720/dq220720a-eng.htm">peaked at over eight per cent in June 2022</a>.</p>
<p>The root cause of this inflation was not domestic like it had been in the 1990s. Rather, it was in response to the COVID-19 pandemic, which affected <a href="https://www.weforum.org/agenda/2022/06/inflation-stats-usa-and-world">all major Western economies</a>. </p>
<p>Canada was not alone in increasing its debt so citizens could stay home and limit the spread of infection. The Bank of Canada <a href="https://www.bankofcanada.ca/2020/05/our-policy-actions-in-the-time-of-covid-19/">lowered the overnight rate to 0.25 per cent</a> and intervened massively to <a href="https://www.bankofcanada.ca/2020/08/our-covid-19-response-large-scale-asset-purchases/">buy the government’s debt</a>.</p>
<p>Initially, <a href="https://thoughtleadership.rbc.com/proof-point-fewer-supply-chain-snarls-wont-be-enough-to-lower-inflation-to-2/">it was believed these inflation increases would reverse as supply chain challenges resolved</a>, so <a href="https://amp.cbc.ca/embed/index.html?preview=0&embed_type=customhtml&content_id=1.6807771&position=0&api=prod">central banks were slow to react</a>.</p>
<p>But this assumption proved false. As the pandemic receded, Canadians began spending <a href="https://www.theglobeandmail.com/business/article-canadians-savings-stockpile-is-a-300-billion-quandary-for-the">the money they had stored away during lockdowns</a>. With low interest rates, the prices of assets like houses and shares dramatically increased. The Russian invasion of Ukraine <a href="https://www.federalreserve.gov/econres/notes/feds-notes/the-effect-of-the-war-in-ukraine-on-global-activity-and-inflation-20220527.html">added another economic shock</a>. </p>
<p>By this point, high inflation had started to become entrenched in the expectations of businesses, unions and individuals. As history shows, once inflation becomes entrenched in the economy, <a href="https://www.imf.org/en/Blogs/Articles/2023/10/04/how-managing-inflation-expectations-can-help-economies-achieve-a-softer-landing">it is very difficult to reverse</a>.</p>
<h2>Taming inflation</h2>
<p>The Bank of Canada, although slow to react, successfully reversed the increasing inflation trend with <a href="https://www.theglobeandmail.com/topics/bank-of-canada">10 interest rate increases between March 2022 and July 2023</a> and by increasing the overnight rate to five per cent.</p>
<p>Inflation fell to 3.1 per cent in <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/231121/dq231121a-eng.htm">October</a> and <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/231219/dq231219a-eng.htm">November 2023</a>, creating optimism about returning to levels that would assure the Bank of Canada that inflation had been tamed.</p>
<p>Despite core inflation remaining stubbornly above three per cent, this relative success allowed the central bank to hold the overnight rate at five per cent, increasing the possibility of lower interest rates. </p>
<p>This confidence was confirmed with the <a href="https://www.cbc.ca/news/business/inflation-january-2024-1.7119796">January CPI coming in at 2.9 per cent</a>, just inside the Bank of Canada’s operating band.</p>
<p>It’s clear that central banks must act as soon as they can to prevent inflationary expectations from becoming entrenched in the economy. Once entrenched, the economy ends up bearing significant pain to reverse it — pain that is not spread evenly across the population.</p>
<h2>Food and shelter costs</h2>
<p>Interest rates and inflation are inextricably linked and they affect households in different ways. The CPI measures the rate of inflation on a basket of goods, but not all households consume every good in the basket, and not all prices increase at the same rate. Therefore, the impact of inflation varies across groups.</p>
<p>Younger, <a href="https://www150.statcan.gc.ca/n1/pub/75-006-x/2023001/article/00002-eng.htm">poorer households spend a disproportionately large portion of their income on food</a>, which has seen major price increases over the last two years. Similarly, those commuting from the outskirts of metropolitan areas faced higher commuting costs when gasoline prices spiked. </p>
<p>However, the biggest anomaly is in housing costs, where increasing interest rates designed to lower inflation automatically <a href="https://www.cpacanada.ca/news/pivot-magazine/2022-02-16-housing-market">translate into higher rental costs and imputed housing costs</a>.</p>
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Read more:
<a href="https://theconversation.com/two-thirds-of-canadian-and-american-renters-are-in-unaffordable-housing-situations-221954">Two-thirds of Canadian and American renters are in unaffordable housing situations</a>
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<p>In its January 2024 CPI report, Statistics Canada reported that rental costs increased by 6.2 per cent year over year, while food price inflation was still up 3.9 per cent. </p>
<p>Together food and shelter costs amount to 45 per cent of the CPI, but younger, poorer households have disproportionately suffered because their price index is skewed more toward food and shelter. </p>
<h2>A waiting game</h2>
<p>The impact of higher interest rates in Canada’s mortgage market depends critically on the maturity of someone’s mortgage and rent controls.</p>
<p>Many households with variable rate mortgages, or those renewing mortgages during this period of high interest rates, <a href="https://theconversation.com/heres-how-the-bank-of-canadas-interest-rate-hike-to-5-will-impact-canadian-households-209369">are struggling with significantly higher mortgage payments</a>.</p>
<p>Additionally, those who know they will have to renew their mortgage in the coming year are taking steps to adjust to those increases. </p>
<p>In fact, approximately 20 per cent of mortgages held by some of Canada’s biggest banks are negatively amortized, meaning homeowner payments do not cover the monthly interest charges. So, each month, <a href="https://www.theglobeandmail.com/business/article-mortgage-borrowers-td-bmo-cibc-homeowners">the amount owed on the mortgage increases</a>. Needless to say, many are urgently hoping for interest rate reductions in 2024.</p>
<p>Right now, the Bank of Canada is waiting to see what happens to inflation in the coming months before deciding whether to hold the overnight rate where it is, decrease it or increase it. This decision hinges on whether it feels the underlying or core rate of inflation aligns with its target zone. </p>
<p>The central bank is well aware that signalling a reduction too early could feed into greater consumer spending and higher inflation. So interest rates could stay where they are for several more months. While shelter and food price inflation will moderate, don’t expect actual prices to revert back to pre-pandemic levels.</p><img src="https://counter.theconversation.com/content/224220/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The real question in the minds of many economists is what the trend in inflation will be going forward, and when interest rates will begin to fall and bring relief to Canadians.Walid Hejazi, Professor of International Business, Rotman School of Management, University of TorontoLaurence Booth, Professor, Rotman School of Management, University of TorontoLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2224602024-02-01T00:24:27Z2024-02-01T00:24:27ZWith the economy looking bright enough, the Federal Reserve seems content to play the waiting game<figure><img src="https://images.theconversation.com/files/572543/original/file-20240131-29-ugwtym.jpg?ixlib=rb-1.1.0&rect=43%2C410%2C5783%2C3468&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">When will Fed Chair Jerome Powell lower the curtains on the inflation battle?</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/FederalReservePowell/90516627fabd4f71b1122b964a78a211/photo?Query=jerome%20powell&mediaType=photo&sortBy=creationdatetime:desc&dateRange=Anytime&totalCount=2461&currentItemNo=1">AP Photo/Alex Brandon</a></span></figcaption></figure><p>If there’s one thing you can say about Fed policymakers, it’s that they don’t make decisions on a whim. When the Federal Open Market Committee met on Jan. 31, 2024, it <a href="https://www.nbcnews.com/business/economy/federal-reserve-interest-rate-decision-january-2024-increase-decrease-rcna136429">held interest rates steady</a> – <a href="https://finance.yahoo.com/news/federal-reserve-leaves-interest-rates-unchanged-tempers-expectations-on-rate-cuts-ahead-190255912.html">as most</a> observers expected. That marks six months since the Fed last changed the base rate.</p>
<p>And people should expect to wait a little while more: Fed Chair Jerome Powell <a href="https://www.cnbc.com/2024/01/31/fed-chief-jerome-powell-says-a-march-rate-cut-is-not-likely.html">said a rate cut was “not likely</a>” to come at the next meeting in March. But over the course of his news conference after the meeting, he emphasized that nothing is set in stone.</p>
<p>The Federal Reserve has what is called a <a href="https://www.stlouisfed.org/in-plain-english/the-fed-and-the-dual-mandate">dual mandate</a>: Its job is to achieve maximum employment and keep prices stable. Often there’s a trade-off between these goals: Cutting rates often helps with the former, while lowering them helps with the latter. </p>
<p>And in recent months, controlling inflation has been the focus of Fed policy. In his remarks on Jan. 31, Powell made it clear that Americans shouldn’t expect the Fed to do anything to rates until the U.S. gets <a href="https://sites.lsa.umich.edu/mje/2023/09/04/why-the-2-inflation-target/#:%7E:text=This%20meant%20that%20costs%20only,and%20an%20increase%20in%20prices.">closer to its target of 2% inflation</a>. And that could take some time.</p>
<p>There’s a reason Powell and his fellow policymakers are focused on the 2% inflation target. So long as <a href="https://www.bls.gov/cpi/">consumer price index inflation</a> is above 2%, the concern is that any lowering of interest rates could stimulate the economy too much and reignite inflation. </p>
<p>Still, the <a href="https://www.federalreserve.gov/monetarypolicy/fomc.htm">federal funds rate</a>, which helps determine mortgage and loan rates and quite a bit more, remains at 5.5%, higher than it’s been in 16 years. The Fed has raised rates 11 times since early 2022. </p>
<p>That aggressive rate-hiking has had the desired effect of putting the brakes on the economy. But it comes with some pain for borrowers – and some are now eager to bring rates back down. </p>
<p>Cutting rates usually makes sense when the economy is getting significantly worse, and there’s not much reason to think that’s happening now. Fourth-quarter gross domestic product grew <a href="https://www.bea.gov/news/2024/gross-domestic-product-fourth-quarter-and-year-2023-advance-estimate">3.3% on an annualized basis</a>, ending 2023 on a strong note. The economy added <a href="https://www.bls.gov/news.release/pdf/empsit.pdf">more than 2 million jobs</a> over the course of 2023. And consumer price index inflation is running at <a href="https://www.bls.gov/news.release/pdf/cpi.pdf">about 3.3% in December 2023</a>.</p>
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<figcaption><span class="caption">The chair of the Federal Reserve addresses reporters on Jan. 31, 2024.</span></figcaption>
</figure>
<p>“This is a good situation,” Powell said during his news conference. “Let’s be honest: This is a good economy.”</p>
<p>So what comes next? The Fed recently indicated that it expects to cut rates <a href="https://www.bloomberg.com/news/articles/2024-01-11/us-inflation-accelerates-tempering-case-for-fed-to-cut-rates?sref=Hjm5biAW">three times in 2024</a>. But as Powell was at pains to make clear, if the data changes, the Fed’s decision-making will, too.</p>
<p>The labor market data looks relatively sunny. There’s greater balance between the number of people who want jobs and the number of open positions than there was last year. Wage growth looks likely to continue at current rates. So unless there’s a sharp increase in unemployment, which <a href="https://apnews.com/article/retail-sales-december-economy-consumer-spending-800f78ae0a4428be3be7733238d16f40">doesn’t seem likely at the moment</a>, there seems to be little reason to cut interest rates.</p>
<p>There’s always a concern that keeping rates too high for too long may tip the economy into a recession. But recent history doesn’t suggest that will happen. </p>
<h2>Taking the long view</h2>
<p>Taking a historical perspective can be revealing. The 30-year fixed mortgage rate is about 6.6% – high by recent standards. However, back in 1998, the year I bought my first home, the rate was 6.9%. At that time, it was a real deal! </p>
<p>Mortgage rates have been as high as 18% if you go back to 1981. That’s not to say either I or the Fed believe there’s room to increase rates any time soon – just that rates are nowhere near record highs.</p>
<p>Powell did say there’s no reason for any rate increases, so the current Federal funds rate of 5.5% is likely the current cyclical peak. </p>
<p>The next meeting will start March 19. The odds are that the U.S. economy will continue to grow, and inflation will continue to moderate – however slowly. So I would expect the Fed to follow through on Powell’s noncommittal prediction and hold off on cutting rates until later in the year.</p>
<p>So there’s no soft landing yet – Powell said as much. But we look surprisingly close.</p><img src="https://counter.theconversation.com/content/222460/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christopher Decker does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The central bank is ‘really in risk management mode,’ its chairman said.Christopher Decker, Professor of Economics, University of Nebraska OmahaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2205572024-01-05T17:12:11Z2024-01-05T17:12:11ZBitcoin: four reasons why the price should surge in 2024<figure><img src="https://images.theconversation.com/files/568019/original/file-20240105-21-pulhq0.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Bitcoin back?</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/crypto-currency-bounces-back-after-fall-2308602413">FAHM198</a></span></figcaption></figure><p>The year 2023 will be remembered as turbulent for cryptocurrencies, with numerous important developments that ultimately helped to “clean up” the space to potentially make it more attractive to mainstream investors. Notably there was <a href="https://theconversation.com/sam-bankman-fried-was-convicted-of-fraud-following-the-collapse-of-the-cryptocurrency-exchange-ftx-heres-what-investors-need-to-know-217026">the conviction</a> of FTX CEO Sam Bankman-Fried for fraud. </p>
<p>Top exchange Binance also reached a <a href="https://www.wsj.com/finance/regulation/binance-copped-a-4-billion-plea-but-is-still-fighting-the-sec-44a4e5a5">US$4 billion settlement</a> (£3.1 billion) with the US treasury department over money-laundering charges, which saw CEO Changpeng “CZ” Zhao agreeing to <a href="https://www.coindesk.com/policy/2023/11/28/changpeng-cz-zhao-steps-down-from-binanceus-board/">step down</a> and pay a US$50 million fine. </p>
<p>Meanwhile, regulators continued <a href="https://theconversation.com/us-regulators-continue-crypto-crackdown-but-heres-why-the-latest-charges-are-different-207332">cracking down</a> on other operators, but potentially lost one of their key cases against the industry after a <a href="https://www.coindesk.com/consensus-magazine/2023/10/20/ripple-is-on-a-winning-streak-but-the-game-isnt-yet-won/">US court ruled</a> that the XRP token, one of the top ten cryptocurrencies, was not a security (meaning a tradeable financial asset like shares or bonds). </p>
<p>This means its creator, Ripple, did not break the law by selling it on exchanges. Viewed as a test case for the majority of cryptocurrencies, the US Securities Exchange Commission (SEC) is <a href="https://www.reuters.com/legal/legalindustry/ripple-effects-developments-following-groundbreaking-decision-sec-v-ripple-labs-2023-12-05/">currently appealing</a>. </p>
<p>While all this was happening, the bitcoin price rose away from the lows of late 2022. It started the year at US$16,000 and ended comfortably above the US$40,000 threshold. </p>
<p>So what does 2024 look like for this sector and what key events are on the horizon?</p>
<h2>1. ETFs</h2>
<p>The SEC may finally be about to greenlight a type of investment vehicle known as an exchange traded fund (ETF) for the general or “spot” bitcoin market. ETFs already exist for everything from oil to the FTSE 100 to even regions and countries. They track the underlying asset, creating an easy way for people to invest without having to buy the asset directly. </p>
<p>Until now, the only ETFs permitted for crypto in the US have been for the <a href="https://www.forbes.com/advisor/investing/cryptocurrency/best-bitcoin-etfs/">futures markets</a>. These niche markets are concerned with where investors think crypto prices are heading in future. </p>
<p><strong>Bitcoin price 2021-24</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing bitcoin price since 2021" src="https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=363&fit=crop&dpr=1 600w, https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=363&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=363&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=457&fit=crop&dpr=1 754w, https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=457&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/568015/original/file-20240105-25-220p44.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=457&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/">Trading View</a></span>
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<p>A spot bitcoin ETF would likely encourage mainstream investors to buy exposure to this market, while potentially attracting banks to actively participate too. Bitcoin could be offered by financial advisors and there would no longer be a need for investors to hold the asset itself or <a href="https://en.bitcoin.it/wiki/Storing_bitcoins">face difficulties</a> like crypto exchanges, coin storage and so on. </p>
<p>There are various reasons why many commentators think the SEC may now end its opposition to such an ETF. For one thing, the list of applicants <a href="https://blockworks.co/tag/blackrock">includes Blackrock</a>, the biggest investment house in the world, along with various other <a href="https://www.coindesk.com/policy/2023/10/23/all-spot-bitcoin-etf-applications-may-be-approved-together-crypto-etf-expert-predicts/#:%7E:text=The%2012%20spot%2Dbitcoin%20ETF,Global%20X%2C%20Hashdex%20and%20Franklin.">major players</a>. </p>
<p>Also, digital asset group Grayscale won an important case against the SEC in 2023, which had been blocking its attempt to convert its US$17 billion bitcoin futures ETF, GBTC, into a spot version. This has forced the SEC to reconsider Grayscale’s application too. </p>
<p>Further, Hong Kong’s regulatory authority has announced it is open to spot bitcoin ETF applications and has <a href="https://www.forbes.com/sites/digital-assets/2023/12/31/hong-kong-spot-bitcoin-etf-signals-bullish-market-shift-more-than-us/?sh=209365697465">laid down guidelines</a> permitting several varieties. As well as the basic model that we may soon see in the US, where investors would buy into bitcoin ETFs with dollars, Hong Kong is open to a second variety known as “in-kind”. </p>
<p>This would make it possible to convert shares in a bitcoin ETF into bitcoin and vice versa, allowing more flexibility and potentially attracting more institutional investors into the space.</p>
<h2>2. Interest rates</h2>
<p>Jerome Powell, chair of US central bank the Federal Reserve, <a href="https://www.theguardian.com/business/2023/dec/13/federal-interest-rates-us-inflation">has indicated</a> that interest rates may have peaked, and that the Fed is likely to cut them during 2024. Similarly in the UK, leading mortgage lender Halifax has cut its <a href="https://www.bbc.com/news/business-67873017">lending rate</a> in expectation of a Bank of England rate cut. </p>
<p>If interest rates are cut or even stabilise in 2024, it could make bitcoin (and other digital assets) more attractive to investors, since its <a href="https://www.blockchain-council.org/cryptocurrency/how-many-bitcoins-are-left/#:%7E:text=December%206%2C%202023-,Summary,million%20left%20to%20be%20mined.">limited supply</a> makes it a hedge against traditional currencies <a href="https://kinesis.money/case-studies/paper-money-eventually-returns-to-its-intrinsic-value-zero/">losing value</a> over time. </p>
<p>More generally, rate cuts prompt investors to look for higher investment returns, and cryptocurrencies have delivered here too. </p>
<p><strong>Asset class returns since 2011</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Table showing asset class returns since 2011" src="https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=320&fit=crop&dpr=1 600w, https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=320&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=320&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=402&fit=crop&dpr=1 754w, https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=402&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/568003/original/file-20240105-15-labr38.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=402&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
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<span class="attribution"><a class="source" href="https://twitter.com/charliebilello/status/1741888124031037686">Charlie Bilello</a></span>
</figcaption>
</figure>
<p>In addition, the US and other economies may enter <a href="https://www.statista.com/statistics/1239080/us-monthly-projected-recession-probability/">a recession</a> in the later half of 2024 due to the lagged effects of the interest rate hikes. </p>
<p>Equally, we saw a number of <a href="https://www.fdic.gov/bank/historical/bank/bfb2023.html">bank failures</a> in 2023, predominantly in the US. In the event of a recession or more bank problems, governments may be forced to provide stimulus packages and print more money. This would further devalue currencies and make bitcoin still more attractive. </p>
<h2>3. The halving</h2>
<p>A big event for bitcoin in 2024 is the so-called “halving”. Bitcoin runs on an online ledger known as a blockchain, in which entries are validated by “miners” using arrays of computers to solve complex mathematical puzzles. Miners are paid in bitcoin for completing a set of transactions known as a block, and the protocol stipulates that their <a href="https://theconversation.com/bitcoin-halving-qanda-what-its-all-about-and-what-it-means-for-the-cryptocurrency-138570">reward per block</a> halves every 210,000 “blocks” (roughly every four years). </p>
<p>The reward began at 50 bitcoin in 2009 and is <a href="https://www.nicehash.com/countdown/btc-halving-2024-05-10-12-00">expected to fall</a> from 6.25 bitcoin to 3.125 bitcoin around the middle of April 2024. </p>
<p>This decrease entails fewer bitcoin sold on the market, which tightens supply and may squeeze out the least efficient miners, significantly reducing the computer power used by the network. The three previous halvings have prompted dramatic bull runs, while also driving up the prices of digital assets more generally as investors take more risks in the space. </p>
<p><strong>Halving effects</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing how bitcoin halvings have affected price" src="https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=364&fit=crop&dpr=1 600w, https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=364&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=364&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=457&fit=crop&dpr=1 754w, https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=457&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/568014/original/file-20240105-17-xer6zm.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=457&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.tradingview.com/">Trading View</a></span>
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</figure>
<h2>4. Blockchain developments</h2>
<p>The bitcoin network saw a number of technological advancements in 2023. This has included enabling a new and <a href="https://forkast.news/bitcoin-nfts-raise-unique-legal-issues/">a unique</a> form of NFTs (non-fungible tokens) known as ordinals, and also a new standard called BRC-20 that makes it possible to create new cryptocurrencies on the network. Until now, NFTs and new cryptocurrencies have mostly been issued on other blockchains such as ethereum. </p>
<p>We are also seeing <a href="https://beincrypto.com/bitcoin-lightning-network-transactions-research/">growing adoption</a> of the Lightning network, a layer above the bitcoin blockchain that enables much faster transactions. All these changes are resulting in <a href="https://www.blockchain.com/explorer/charts/avg-block-size">increased demand</a> for bitcoin, which in turn may lead to higher prices.</p>
<p>In sum, there’s a strong case for being bullish about bitcoin’s price in the year ahead. <a href="https://www.cnbc.com/2024/01/01/bitcoin-btc-price-predicitions-for-2024.html">Commentators’ predictions</a> range from US$60,000 to US$500,000 by year end. Our own belief is that though the road may be bumpy, 2024 could well see increased adoption of cryptocurrencies, which will drive prices beyond the current US$40,000 mark.</p><img src="https://counter.theconversation.com/content/220557/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Urquhart owns some cryptocurrencies.</span></em></p><p class="fine-print"><em><span>Hossein Jahanshahloo does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Twelve months ago, bitcoin looked dead in the water. Now it could be heading to all-time highs.Andrew Urquhart, Professor of Finance & Financial Technology, ICMA Centre, Henley Business School, University of ReadingHossein Jahanshahloo, Assistant Professor in Finance, Cardiff UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2200382023-12-19T19:02:10Z2023-12-19T19:02:10ZInterest rates will eventually fall but it’s a bit early for borrowers to break out the champagne<figure><img src="https://images.theconversation.com/files/566491/original/file-20231219-19-b7zt40.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Shutterstock</span> </figcaption></figure><p>Suddenly the talk in <a href="https://www.ft.com/content/0e7c2224-fa5b-45fc-b598-88010a912a97?desktop=true&segmentId=d8d3e364-5197-20eb-17cf-2437841d178a#myft:notification:instant-email:content">global financial markets</a> has spun from “when will interest rates next rise?” to “how soon before they fall?”.</p>
<p>Some commentators are flagging the shift as a “<a href="https://www.youtube.com/watch?v=VJGd7ZC6xXk">pivot party</a>”.</p>
<p>This change has been most prominent in the United States. It was prompted by the Federal Reserve, the US equivalent of the Reserve Bank of Australia, releasing its latest “dot chart”. This shows most members of its policy-setting Federal Open Market Committee expect their interest rate would be lower by the end of 2024.</p>
<figure class="align-center ">
<img alt="FOMC participants’ assessments of appropriate monetary policy" src="https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566454/original/file-20231219-27-x9107x.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><a class="source" href="https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20231213.htm">US Federal Reserve</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
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<p>The recent <a href="https://rbareview.gov.au/">review of the Reserve Bank</a> in Australia wanted more transparency. But, after the whacking former Governor Phil Lowe got when he wrongly predicted rates would stay low until “at least” 2024, I doubt his successor Michele Bullock will be keen to publish a similar chart. </p>
<p>Even so, financial markets in Australia are also now implying interest rates will fall over the course of next year.</p>
<p><iframe id="lGu8a" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/lGu8a/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<h2>The latest indicators</h2>
<p>The Australian economy has continued to slow according to the latest <a href="https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-national-income-expenditure-and-product/latest-release">national accounts</a>. Consumer spending did not increase at all in the September quarter, despite an increase in population. Exports contracted. Overall GDP grew by a mere 0.2%.</p>
<p><iframe id="AXbhd" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/AXbhd/6/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>The <a href="https://www.abs.gov.au/statistics/labour/employment-and-unemployment/labour-force-australia/latest-release">news from the labour market</a> was mixed. There was a solid rise in employment in November. The hours worked data, however, have been basically flat for the past six months.</p>
<p><iframe id="xifjR" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/xifjR/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>The government maintained fiscal discipline in the <a href="https://theconversation.com/theres-a-glimmer-of-hope-in-the-mid-year-budget-update-but-inflation-is-still-a-big-challenge-219611">mid-year</a> budget update released last week. They saved rather than spent almost all the extra revenue from higher than expected commodity prices.</p>
<p>The <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2023/2023-12-05.html">minutes</a> of the Reserve’s latest meeting on December 5 show the board noted “encouraging signs of progress” in returning inflation to the target.</p>
<p>Subsequent events have suggested inflation will likely continue on its downward trajectory, which means the Reserve has increased interest rates enough.</p>
<p><iframe id="z2Fdb" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/z2Fdb/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Another development since the Reserve last met is an update of the
<a href="https://www.rba.gov.au/monetary-policy/framework/stmt-conduct-mp-8-2023-12-08.html">Statement on the Conduct of Monetary Policy</a> between Treasurer Jim Chalmers and the board. This sets out the common understanding between them about Australia’s monetary policy framework.</p>
<p>Much of this statement carries over the existing framework. The bank’s primary tool is its cash rate target and it is varied to achieve a medium-term inflation target of 2-3%. Employment considerations influence how quickly it is regained when shocks move inflation away from it.</p>
<p>The statement explicitly refers to the midpoint of the target, reflecting a suggestion in the recent <a href="https://rbareview.gov.au/">Reserve Bank review</a>. Some <a href="https://www.afr.com/policy/economy/rba-dual-mandate-tweak-could-mean-higher-rates-for-longer-20231208-p5eq1q#:%7E:text=Treasurer%20Jim%20Chalmers%20has%20axed,rates%20stay%20higher%20for%20longer.">commentators have interpreted</a> this as indicating the bank cannot cut rates as its <a href="https://www.rba.gov.au/publications/smp/2023/nov/pdf/05-economic-outlook.pdf">forecast for inflation</a> only has it reaching the top, not the middle, of the range by the end of 2025.</p>
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Read more:
<a href="https://theconversation.com/the-7-charts-that-show-australians-struggling-as-saving-falls-to-near-zero-218924">The 7 charts that show Australians struggling as saving falls to near zero</a>
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<p>I disagree. The bank has always aimed at the midpoint of the target as the most likely way to ensure inflation averages within it. If the board was happy at its December meeting to have reached 3% by the end of 2025 on its way to achieving 2.5% later, there is no reason for it to change this view in February.</p>
<h2>So what will the Reserve Bank do?</h2>
<p>On balance, the economic news does not suggest the Reserve Bank will feel a need to raise rates in February. But with inflation still high, and plenty of uncertainty, they are unlikely to cut rates any time soon. The bank does not generally make sharp U-turns with the average gap between the last interest rate increase in a cycle and the first cut being ten months.</p>
<p>At its next meeting, on <a href="https://www.rba.gov.au/media-releases/2023/mr-23-18.html">February 5-6</a>, the Reserve board may have a new member, deputy governor <a href="https://theconversation.com/meet-andrew-hauser-the-outsider-from-the-uk-wholl-be-deputy-governor-of-the-rba-217521">Andrew Hauser</a>, and a new adviser, chief economist <a href="https://www.rba.gov.au/media-releases/2023/mr-23-36.html">Sarah Hunter</a>. They share a British background so will be familiar with the Bank of England model, which influenced the <a href="https://www.theguardian.com/commentisfree/2023/apr/21/the-reserve-bank-review-is-not-revolutionary-and-thats-a-good-thing">Reserve Bank review</a>. </p>
<h2>The impact of (eventual) lower interest rates</h2>
<p>The movements in the Reserve Bank’s interest rate matters most to the third of households with a mortgage. Most of these have variable rate loans where the interest rate closely follows that set by the Reserve. An interest rate cut would ease the cost-of-living pressures they have been facing. </p>
<p>A household with the <a href="https://www.abs.gov.au/statistics/economy/finance/lending-indicators/latest-release">average loan size of around A$600,000</a> would have seen their monthly repayments rise by almost $1,700 since early 2022. This would drop by $100 if rates were cut by 0.25%.</p>
<p>While the impact on mortgagees always gets the most attention, interest rates affect other members of the community too.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/will-the-rba-raise-rates-again-unless-prices-surge-over-summer-its-looking-less-likely-219197">Will the RBA raise rates again? Unless prices surge over summer, it's looking less likely</a>
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<p>Lower interest rates mean a lower income to retirees dependent on interest on their savings. They tend to boost the prices of assets such as shares and houses. They encourage borrowing and spending and reduce incentives to save. They tend to lower the exchange rate, making imports more expensive for Australians but our exports cheaper to foreigners. The net impact is generally to lower unemployment.</p>
<p>A lot of people are therefore looking forward to an interest rate cut. But they should not be holding their breath.</p>
<p>Financial markets may be getting prematurely excited. The last thing the Reserve Bank would want is to find themselves having lowered rates too quickly and see inflation turn back up, necessitating the interest rate cut to be reversed. More likely, they will wait for inflation to drop much closer to their target before there is any easing of interest rates.</p><img src="https://counter.theconversation.com/content/220038/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Hawkins is a former senior economist at the Reserve Bank and has worked as an economic forecaster at the Bank for International Settlements and the Australian Treasury.</span></em></p>A lot of Australians are hoping there might be an interest rate cut at the next Reserve Bank board meeting but they shouldn’t hold their breath.John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2198572023-12-19T16:54:29Z2023-12-19T16:54:29ZInterest rates have stopped rising, but 2023 hikes could still cause recession for some economies<figure><img src="https://images.theconversation.com/files/566140/original/file-20231217-29-oomab8.jpg?ixlib=rb-1.1.0&rect=40%2C17%2C2946%2C1949&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central banks in the US, UK and Europe have been trying to slow inflation without creating a recession.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/inflation-reduction-act-by-fed-federal-2218228849">eamesBot/Shutterstock</a></span></figcaption></figure><p>Central banks on both sides of the Atlantic kept their main interest rates unchanged for the fourth successive month in December 2023. These rates are closely watched because they set the minimum interest at which your bank borrows and lends. This determines the cost of credit for all firms and households with mortgages or other loans. </p>
<p>The European Central Bank (ECB), the US Federal Reserve and the UK Bank of England have raised interest rates sharply since the start of 2022. This was in response to a surge in inflation – the annual increase in consumer prices – far above the 2% rate that all these central banks now target. </p>
<p>But UK inflation is taking longer to respond than that of the US or EU. This has renewed debate over <a href="https://theconversation.com/interest-rate-hikes-are-not-the-only-tool-to-fight-uk-inflation-heres-what-the-government-should-do-208697">whether rate cuts are the best or only way</a> to keep inflation under control. It has also caused a shift in opinions about which western economies are most at risk of recession in 2024.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/is-the-uk-in-a-recession-how-central-banks-decide-and-why-its-so-hard-to-call-it-191237">Is the UK in a recession? How central banks decide and why it's so hard to call it</a>
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<p>Higher interest rates are designed to subdue inflation by reducing the amount people spend. Businesses and households are expected to save more when rates rise, in anticipation of greater interest payments (<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">although that doesn’t always happen</a>). It’s also hoped they’ll borrow less because of the extra interest they would be charged. Those with outstanding loans are left with less to spend on goods and services after paying their interest bill. </p>
<p>Governments are also affected. In the UK, interest on around a quarter of government debt is now <a href="https://www.nao.org.uk/press-releases/managing-government-borrowing/#:%7E:text=The%20type%20of%20debt%20that,to%20lenders%20rise%20with%20inflation.">linked to inflation</a>. This means more of the budget gets channelled into interest payments, leaving less to spend on public services, when the central bank raises rates.</p>
<p>This restraint doesn’t happen immediately, however. When borrowers take out fixed-rate loans, they aren’t affected by higher base rates until the deal expires. Almost a million UK borrowers, for example, are still on fixed rates of 2% or below that will only <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">come up for renewal</a> – at current, higher rates – in the first quarter of 2024. The resulting delay of a year or more before past interest rate rises kick in makes it hard for central bankers to know when they’ve raised rates enough to cool the economy.</p>
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<strong>
Read more:
<a href="https://theconversation.com/uk-bonds-have-hit-a-25-year-high-heres-what-that-means-for-the-economy-215188">UK bonds have hit a 25-year high – here's what that means for the economy</a>
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<p>Raising interest rates can also restrain inflation by encouraging foreign investors to buy bonds and other financial assets in a country’s currency. The resulting inflow of capital is likely to strengthen its exchange rate. This makes imports cheaper and can help to slow the overall rise in prices. </p>
<p>A stronger currency is especially effective for curbing inflation for economies that consume a high proportion of imports, such as the UK. But it also hurts exporters, and only works if interest rates rise above those of comparable economies. This may be one reason why the Bank of England has raised its interest rates faster and further than the ECB since February 2022.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the main central bank rates for UK, US, Europe staying low from 2012-2016 (except the US) and then rapidly rising at the end of 2021. Also shows Japan, which has stayed low thoughout." src="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.statista.com/chart/21070/main-policy-interest-rates-in-selected-countries-and-regions/">Statista</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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</figure>
<h2>Divergence ahead</h2>
<p>Although they hiked rates in similar fashion in 2022-23, these central banks are set to go different ways in 2024. </p>
<p>US rates are set to fall as inflation drops back towards the 2% target, having already slowed to 3.1% in November 2023 (from 6.4% in January). The US Federal Reserve has signalled two likely interest rate reductions, totalling 0.75%, in 2024. That’s falling into line with investors’ expectations, which can be gauged by the prices they’re prepared to pay for <a href="https://www.chathamfinancial.com/insights/what-is-a-forward-curve">trading or swapping</a> debt due at a future date and by interest rates on <a href="https://data.oecd.org/interest/long-term-interest-rates-forecast.htm">government bonds that mature several years from now</a>.</p>
<p>While the ECB’s forward guidance is less clear, its governor <a href="https://www.ecb.europa.eu/press/pressconf/2023/html/ecb.is231214%7Edf8627de60.en.html">has hinted at</a> a similar downward path in 2024 because projections now point to headline inflation dropping to 2.1% in 2025 – a year earlier than previously predicted. Eurozone inflation has already slowed sharply, to 2.4% in November from 8.5% in February 2023, despite the ECB keeping its interest rates lower than the US and UK throughout the recent tightening phase. That’s largely because, even though member states set their own fiscal policy, EU rules keep them on <a href="https://economy-finance.ec.europa.eu/system/files/2023-04/COM_2023_240_1_EN.pdf">a tight rein</a> when it comes to spending and debt levels.</p>
<p>In contrast the Bank of England has warned that its base rate, already higher than the EU’s, is likely to stay at 5.25% <a href="https://www.ft.com/content/6425c756-0ff7-42f3-9022-01be30da07fd">“for an extended period of time”</a>. Inflation (on its targeted consumer price index) slowed to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">4.6% in October</a>, well down from its peak above 11% in October 2022, but the average household is braced for more cost of living increases including <a href="https://www.gov.uk/government/publications/energy-bills-support/energy-bills-support-factsheet-8-september-2022">a mid-winter 5% rise</a> in the energy price cap. The recent <a href="https://www.cnbc.com/2023/10/03/sterling-had-its-worst-month-for-a-year-and-it-may-fall-further.html">weakening of the pound</a> against the dollar has also added to industries’ raw material costs, and could worsen if UK interest rates fall too soon. </p>
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<strong>
Read more:
<a href="https://theconversation.com/inflation-has-affected-the-uk-us-and-europe-differently-heres-what-this-means-for-interest-rates-218561">Inflation has affected the UK, US and Europe differently – here's what this means for interest rates</a>
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<h2>Recession threat isn’t over</h2>
<p>The UK economy, while hardly growing this year, has defied the Bank’s earlier <a href="https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022">forecast of a recession</a> from the end of 2022. But because this encouraged the bank into another near-doubling of base rates – from 2.25% in October 2022 to 5.25% from August 2023 – a UK recession in 2024 is still <a href="https://www.fitchsolutions.com/bmi/country-risk/uk-recession-2024-sluggish-rebound-bond-rollovers-take-their-toll-27-10-2023">expected by some commentators</a>. Unfortunately, consumer spending has been <a href="https://www.imf.org/en/Publications/selected-issues-papers/Issues/2023/07/13/Enhancing-Business-Investment-in-the-United-Kingdom-536320">less affected</a> by higher borrowing costs than private and public investment, which ultimately drive economic growth. </p>
<p>More ominously for US president Joe Biden, current interest rate patterns suggest the US could also be <a href="https://www.usbank.com/investing/financial-perspectives/market-news/treasury-yields-invert-as-investors-weigh-risk-of-recession.html">heading for recession</a> in a presidential election year. Most US GDP forecasts for 2024 remain in the 1.5-2.0% range, but that’s well down from the <a href="https://www.bea.gov/news/2023/gross-domestic-product-third-quarter-2023-advance-estimate">4.9% reached in third-quarter 2023</a>. Against this backdrop, the eurozone’s official forecast of <a href="https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts/autumn-2023-economic-forecast-modest-recovery-ahead-after-challenging-year_en">1.2% growth in 2024</a> could be seen as a relatively strong performance since it’s not expected to slow as much as the US is predicted to in 2024.</p>
<p>So, borrowers already hit by higher costs can expect some relief in 2024. But that’s partly due to growing concern that, with <a href="https://blogs.worldbank.org/developmenttalk/commodity-markets-outlook-eight-charts-0">falling global commodity prices</a> already helping to subdue inflation, central bankers may have applied the brakes too hard since 2022, endangering a global recovery.</p><img src="https://counter.theconversation.com/content/219857/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Market expectations for rate cuts sooner rather than later have been dashed but some economies remain in danger of recession.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2189242023-12-06T05:37:11Z2023-12-06T05:37:11ZThe 7 charts that show Australians struggling as saving falls to near zero<figure><img src="https://images.theconversation.com/files/563845/original/file-20231206-16-sl5twe.png?ixlib=rb-1.1.0&rect=239%2C297%2C1533%2C651&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>The national accounts released by the Australian Bureau of Statistics show economic growth slid to a measly <a href="https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release">0.2%</a> in the last quarter. </p>
<p>That’s well down from a low 0.4% in the June quarter. </p>
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<p>Of course, economic growth is not everything. The national accounts don’t measure, for example, unpaid work at home or caring work, volunteering work, or the state of Australia’s environment. </p>
<p>That said, other things being equal, it is better to have economic growth than a recession. Economic growth creates jobs and opportunities. </p>
<p>The miserably low rate of economic growth unveiled on Wednesday is cause for concern. </p>
<h2>GDP per head is shrinking</h2>
<p>Among the many reasons for the collapse, the most obvious is high interest rates. </p>
<p>Treasurer Jim Chalmers said the slump was an “<a href="https://ministers.treasury.gov.au/ministers/jim-chalmers-2022/transcripts/press-conference-canberra-3">inevitable consequence</a>” of higher interest rates and international uncertainty.</p>
<p>For individual Australians, it was even worse – growth per head went backward, in what some economists call a “per capita recession”. </p>
<p>GDP per capita fell 0.5% in the quarter to be down 0.3% over the year. </p>
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<p>Disposable income per head fell for the second consecutive quarter.</p>
<p>In the September quarter it slid 1.4% after sliding 1.7% in the June quarter.</p>
<p>Disposable income is buying power adjusted for inflation, after tax. For households coming off fixed mortgages, the collapse is much greater.</p>
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<p>The slide in ready income has forced households in aggregate to as good as stop saving in order to make ends meet. </p>
<p>The household saving ratio has dropped from a peak of 20.4% of income during the COVID lockdowns to just 1.1% – the least in 16 years.</p>
<p>The ultra-low aggregate rate means that while some households are saving, many are using up what they had previously put away.</p>
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<p>The real value of household spending grew not at all in the September quarter and climbed only 0.4% over a year in which Australia’s population grew by more than 2.4%.</p>
<p>The Bureau of Statistics said some of the restraint in recorded household spending was a statistical anomaly, caused by the treatment of government measures including electricity rebates and expansion of the childcare subsidies, which saw increased government spending on behalf of households.</p>
<p>The one bright spot identified by the bureau was “large-scale events including the 2023 FIFA Women’s World Cup” (go Matildas!). This helped push up spending on hotels, cafes and restaurants 0.9% and transport 3.9%.</p>
<h2>Productivity turning back up</h2>
<p>One positive from the depressing national accounts is that they will cause the Reserve Bank to think harder about whether further interest rate rises are needed. </p>
<p>Chalmers said the figures showed consumption was flat <a href="https://ministers.treasury.gov.au/ministers/jim-chalmers-2022/transcripts/press-conference-canberra-3">before</a> the bank’s November rate rise, and it was open to the bank to explain “what if anything today’s outcome means for their own forecasts”.</p>
<p>Another bright spot is productivity. After falling for five consecutive quarters, GDP per hour worked climbed 0.9% in the September quarter, allowing the bank to feel more relaxed about wage rises above its inflation target.</p>
<p>The drivers of productivity are complex, with skills and training, management quality, investment, competition and innovation all part of the picture. The Australian treasury published a <a href="https://treasury.gov.au/sites/default/files/2022-10/p2022-325290-overview.pdf">good overview</a> of what is involved late last year.</p>
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<p>In bad news for incomes, Australia’s terms of trade fell 2.6%.</p>
<p>The terms of trade measure the price we get for exports compared to the price we pay for imports. They are down 9% from their peak last year.</p>
<p>Export prices fell by 1.4% in the quarter due to lower prices for coal and gas exports. Import prices climbed 1.2%.</p>
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<p>The changed trading environment helped push Australia’s current account back into deficit after five years in which it has been mostly in surplus.</p>
<p>The current account records the value of the flow of goods, services and income between Australian residents and the rest of the world. In the September quarter we sent more money out of Australia than came in.</p>
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<p>The current account is volatile. While we have grown used to surpluses, we cannot expect the odds to be <a href="https://thehungergames.fandom.com/f/p/4400000000000007091">ever in our favour</a>. </p>
<p>A more dynamic economy would help. That would mean more creation (and destruction) of companies. More investment in skills and training would help this along. </p>
<p>Greater dynamism is a challenge for everyone – one we have to meet to improve our chances of better news in future national accounts.</p><img src="https://counter.theconversation.com/content/218924/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen Bartos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Australia’s household saving ratio has collapsed from a high of 20% at the start of the decade to just 1.1%.Stephen Bartos, Professor of Economics, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2185612023-11-29T14:07:35Z2023-11-29T14:07:35ZInflation has affected the UK, US and Europe differently – here’s what this means for interest rates<p>The Bank of England’s governor has <a href="https://www.bbc.co.uk/news/articles/cjrpzxpv90eo">repeatedly warned</a> that it will not cut UK interest rates <a href="https://www.cnbc.com/2023/11/02/bank-of-england-leaves-interest-rates-unchanged.html">any time soon</a>, even with a recent sharp fall in consumer price inflation. </p>
<p>Like central banks in the US and eurozone, the bank has been sharply increasing its base rate to try to tame a spike in inflation. But this has increased the interest people must pay on loans like mortgages, as well as businesses’ financing costs, leading to <a href="https://www.reuters.com/markets/rates-bonds/uk-economy-shows-signs-slowdown-boe-rate-hikes-mount-2023-08-23/">an economic slowdown</a>.</p>
<p>Inflation has roared back around the world over the past two years after many years of “low-flation”. A period of slow consumer price growth since the mid-2010s had left central banks struggling for ways to stimulate economic activity. But how they have tackled inflation since have diverged in line with the specific issues and items driving price growth in each economy. Understanding these differences could shed light on the likely direction of interest rates in the coming months.</p>
<p>When COVID hit and lockdown measures stopped the economy altogether, price pressures fell even more than they had during the low-flation period. Some inflation gauges even turned negative. The world’s major central banks used more monetary stimulus to keep their economies afloat. The eurozone implemented the pandemic emergency purchase programme (<a href="https://www.ecb.europa.eu/mopo/implement/pepp/html/index.en.html">PEPP</a>), while <a href="https://www.bankofengland.co.uk/coronavirus">the UK</a> and <a href="https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic">the US</a> came up with similar measures. </p>
<p>The COVID recession also had a particularly pronounced effect on energy prices – US <a href="https://www.bbc.co.uk/news/business-52350082">oil prices even went negative</a> for a few days in March 2020.</p>
<p>But this shock was temporary. As lockdowns eased throughout the western world in the second half of 2020 and into 2021, the economy jumped back quickly. This happened faster and to a greater extent than anyone had anticipated thanks to the stimulus programmes countries enacted. </p>
<h2>Diverging fortunes</h2>
<p>Of course, since every country didn’t experience this snapback at the same time, global supply chains could not keep up. Production in some countries was still in lockdown, while in others factories were ramping up production as people in recovering countries were starting to buy again. Orders became backlogged and shipments were queued. </p>
<p><a href="https://theconversation.com/global-economy-2023-covid-19-turned-global-supply-chains-upside-down-3-ways-the-pandemic-forced-companies-to-rethink-and-transform-how-they-source-their-products-196764">These bottlenecks</a> led to shortages and price hikes for many goods – from <a href="https://www.cnbc.com/2021/08/25/auto-industry-supply-chains-hit-hardest-during-covid-pandemic-survey.html">cars</a> to <a href="https://www.reuters.com/technology/apples-iphone-shipments-seen-sagging-under-china-disruptions-2022-11-30/">phones</a> to over-the-counter <a href="https://www.fastcompany.com/90828462/from-baby-formula-to-tylenol-2022-was-the-year-in-shortages-but-whats-in-store-for-2023">pain meds and baby formula</a>.</p>
<p>Energy prices also shot up again. Crude oil prices reached pre-pandemic levels by <a href="https://www.investopedia.com/articles/investing/100615/will-oil-prices-go-2017.asp#:%7E:text=9-,WTI%20closed%20out%202020,-at%20around%20%2448">the end of 2020</a> and surpassed them throughout 2021. So even before the Russian invasion of Ukraine in February 2022, energy prices and the reopening of the economy were pushing inflation up.</p>
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<strong>
Read more:
<a href="https://theconversation.com/russia-ukraine-war-has-nearly-doubled-household-energy-costs-worldwide-new-study-200104">Russia–Ukraine war has nearly doubled household energy costs worldwide – new study</a>
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<p>The outbreak of the war in Ukraine gave energy prices another jolt, of course – especially natural gas in Europe. This led <a href="https://www.bankofengland.co.uk/explainers/will-inflation-in-the-uk-keep-rising#:%7E:text=For%20example%2C%20if%20there%20is,'cost%2Dpush'%20inflation.">central banks to argue</a> they were fighting global cost-push inflation. This means external factors were pushing up the prices of key goods, leaving central banks with little control. </p>
<p>But a closer look at the figures shows that the inflation stories in the three major economies of the US, UK and eurozone had already started to diverge at this point. Since then, they have become even more different. </p>
<p>In all three, inflation peaked at close to 10% in the second half of 2022, but the drivers differed. The following charts show the major contributors to overall consumer price inflation in each of these regions were energy, food and then services and other goods.</p>
<p>In the eurozone, inflation was mostly due to higher energy and, later, food prices:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing headline inflation, and that for energy, food and all other items in the Eurozone rising to a peak in October 2022 before falling again." src="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<p>But in the UK the prices of non-energy, non-food items were more important to the inflationary push: </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing headline rate of UK inflation and that for energy, food and all other items, rising until October 2022 before falling again." src="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<p>As they were in the US:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing headline rate of US inflation and that for energy, food and all other items, rising until October 2022 before falling again." src="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<h2>The current inflation picture</h2>
<p>Now the height of the pandemic is behind these economies, supply chain pressures have eased, and energy prices are back to pre-war levels – hence the fall in inflation that’s <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23">now being reported</a> relative to last year. </p>
<p>But the latest headline inflation figures (October 2023) show that another item is now causing these three economies to diverge: housing. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Three bar charts showing the differing composition of inflation between the US, Eurozone and UK in the October 2023 inflation data." src="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=360&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=360&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=360&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=452&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=452&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=452&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The items that fuelled price inflation in the US, UK and Eurozone headline inflation rates in October 2023.</span>
<span class="attribution"><span class="source">US Bureau of Labor Statistics, Eurostat and UK Office for National Statistics</span></span>
</figcaption>
</figure>
<p>The US and the eurozone have similar headline inflation rates. But in the US, inflation is mainly driven by housing costs (which may be partly due to the way housing costs are measured in the US). In the eurozone, however, energy prices are now dragging down the rate of inflation – although that is offset to a large extent by food prices, which have continued to rise. </p>
<p>On the other hand, the UK has a higher inflation rate and the “all other items” category is now the biggest driver of price rises. So, in the UK, price increases across the board mean that inflationary pressures have spread from a few sectors, like energy or housing, to the broader economy. This makes inflation more sticky and requires more policy tightening to cool down the economy.</p>
<figure class="align-center ">
<img alt="Person holding empty wallet open, over credit cards and bills." src="https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Monetary policy tightening can include rate rises, which increase rates on loans and mortgages.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/credit-card-debt-holding-empty-wallet-421745821">Yingzaa_ST/Shutterstock</a></span>
</figcaption>
</figure>
<h2>More interest rate rises to come?</h2>
<p>All of this shows that, in the US and the eurozone there is little sign of broad-based inflation pressures at the moment. If energy prices remain constant and food prices stabilise, inflation might soon return to close to the 2% target most central banks aim for, even without further action by the US Federal Reserve and the European Central Bank. </p>
<p>The UK, by contrast, seems to have a more standard inflation problem with price pressures across a wider set of items that still need to be contained. This leaves the Bank of England with a harder job to do to bring inflation under control. </p>
<p>And so, we can expect inflation to keep slowing in the eurozone and the US without much intervention. In the UK, however, further action might be needed if the Bank of England is to keep price rises under control.</p><img src="https://counter.theconversation.com/content/218561/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The UK, eurozone and US inflation stories have diverged, which means each economy is now fighting a distinct battle with prices rises, which could require very different weapons.Pietro Galeone, Research fellow, Bocconi UniversityDaniel Gros, Professor of Practice and Director of the Institute for European Policymaking, Bocconi UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2179792023-11-29T13:40:14Z2023-11-29T13:40:14ZWhy the Fed should treat climate change’s $150B economic toll like other national crises it’s helped fight<p>Climate disasters are now costing the United States <a href="https://nca2023.globalchange.gov/">US$150 billion per year</a>, and the economic harm is rising.</p>
<p>The <a href="https://www.cnn.com/2023/11/07/homes/homeowners-insurance-climate-real-estate/index.html">real estate market</a> has been disrupted as home insurance rates skyrocket along with rising wildfire and flood risks in the warming climate. <a href="https://www.cbsnews.com/news/climate-change-food-prices-inflation-3-percent-study/">Food prices</a> have gone up with disruptions in agriculture. <a href="https://www.americanprogress.org/article/the-health-care-costs-of-extreme-heat/">Health care costs</a> have increased as heat takes a toll. Marginalized and already vulnerable communities that are least financially equipped to recover are <a href="https://nca2023.globalchange.gov/chapter/31/#key-message-1">being hit the hardest</a>.</p>
<p>Despite this growing source of economic volatility, the Federal Reserve – the U.S. central bank that is charged with maintaining economic stability – is <a href="https://www.brookings.edu/articles/why-the-fed-and-ecb-parted-ways-on-climate-change-the-politics-of-divergence-in-the-global-central-banking-community/">not considering the instability of climate change</a> in its monetary policy. </p>
<p>Earlier this year, Fed <a href="https://www.federalreserve.gov/newsevents/speech/powell20230110a.htm">Chair Jerome Powell declared</a> unequivocally: “We are not, and we will not become, a climate policymaker.”</p>
<p>Powell’s rationale is that to maintain the Fed’s independence from politics and political cycles, it should use <a href="https://www.federalreserve.gov/aboutthefed/the-fed-explained.htm">its tools</a> narrowly to focus on its core <a href="https://www.federalreserve.gov/boarddocs/rptcongress/98frgpra.pdf">mission of economic stability</a>. That includes price stability, meaning keeping inflation low and maximizing employment. In Powell’s view, the Fed should stay away from social and environmental concerns that are not tightly linked to its statutory goals. </p>
<figure class="align-center ">
<img alt="Powell, in a suit and tie, sits at a large desk in hearing room with papers in front of him and a name tag. He's looking up over the top of his glasses at the camera." src="https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=392&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=392&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=392&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=492&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=492&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=492&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Federal Reserve Chairman Jerome Powell testifies before the House Committee on Financial Services on June 21, 2023.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/federal-reserve-chairman-jerome-powell-testifies-before-the-news-photo/1500340373">Win McNamee/Getty Images</a></span>
</figcaption>
</figure>
<p>However, it is getting <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230110%7E21c89bef1b.en.html">increasingly difficult for central banks</a> to ensure stability if they do not integrate climate instability into their monetary policies.</p>
<p>As researchers with expertise in <a href="https://cssh.northeastern.edu/faculty/jennie-stephens/">climate justice</a> and <a href="https://www.tcd.ie/research/profiles/?profile=sokolm">central banks</a>, we recently <a href="https://doi.org/10.1080/17565529.2023.2268589">published a paper</a> reviewing the monetary policy tools available to central banks around the world that could help slow climate change and reduce climate vulnerabilities.</p>
<p>With the new U.S. <a href="https://nca2023.globalchange.gov/">National Climate Assessment</a> and <a href="https://doi.org/10.1007/s10584-022-03319-w">other research</a> making clear that U.S. policies and actions are <a href="https://climateactiontracker.org/countries/usa/#">insufficient to minimize climate instability</a> and manage the growing economic costs, we believe it’s time to <a href="https://www.climate-transparency.org/wp-content/uploads/2021/08/ODI_role-of-central-banks-in-tackling-climate-change.pdf">reconsider the role of central banks</a> in <a href="https://unfccc.int/news/new-analysis-of-national-climate-plans-insufficient-progress-made-cop28-must-set-stage-for-immediate">responding to the climate crisis</a>.</p>
<h2>Rethinking interest rates</h2>
<p>One thing central banks could do is set lower interest rates for renewable energy development. The <a href="https://www.bloomberg.com/news/articles/2021-07-16/boj-takes-careful-first-step-on-green-loans-stands-pat-on-rates?sref=Hjm5biAW">Bank of Japan has used this strategy</a>. </p>
<p>The Fed’s aggressive increases in interest rates in response to rising inflation have <a href="https://doi.org/10.1038/s41893-019-0375-2">slowed the transformation</a> toward a more sustainable society by <a href="https://www.wsj.com/articles/fed-programs-have-kept-finance-flowing-to-fossil-fuels-11637317801">supporting fossil fuels</a> and making <a href="https://time.com/6281021/renewable-energy-interest-rates/">investments in renewable energy</a> infrastructure more expensive. <a href="https://www.reuters.com/sustainability/why-us-offshore-wind-industry-is-doldrums-2023-10-31/">Offshore wind</a> power has been particularly hard hit, with multiple multibillion-dollar projects canceled as higher interest rates raised the projects’ costs.</p>
<figure class="align-center ">
<img alt="The foundation of an offshore wind turbine tower without the top yet, and a construction crane and another tower in the background." src="https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Offshore wind turbines are under construction off Massachusetts, but high interest rates raised the cost of projects so much that some companies have put plans on hold.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/OffshoreWindsJobs/582b66f7df9a43488d3bf7a71e84b914/photo">AP Photo/Charles Krupa</a></span>
</figcaption>
</figure>
<p>One way to introduce differentiated rates would be to create a special <a href="https://www.federalreserve.gov/funding-credit-liquidity-and-loan-facilities.htm">lending facility</a> under which commercial banks could borrow money from the central bank at preferential interest rates if used for renewable energy deployment or other climate-friendly investments. Whether the Fed already has authorization to do that depends on interpretation of its current mandate. </p>
<p>While the U.S. Federal Reserve has not done it before, <a href="https://www.bloomberg.com/news/articles/2023-01-29/china-central-bank-extends-use-of-tools-to-promote-green-lending">China’s central bank</a> has <a href="https://greencentralbanking.com/central-banks/peoples-bank-of-china/">used similar tools</a> to incentivize renewable energy, and the Bank of Japan’s lending facility offers <a href="https://greencentralbanking.com/2022/08/02/japan-green-lending-scheme-sayuri-shirai/">zero-interest loans</a> for green investments. </p>
<h2>Nudging banks to rethink investments</h2>
<p>Despite the Fed’s proclaimed efforts not to pick winners and losers, its monetary policies have taken steps that <a href="https://www.nytimes.com/2023/02/25/business/economy/federal-reserve-powe.html">favor established industries and companies</a>, including the fossil fuel industry.</p>
<p>For example, the Fed <a href="https://www.brookings.edu/articles/fed-response-to-covid19/">supported the financial sector unconditionally</a> during the COVID-19 pandemic to keep credit available to limit economic harm. Its massive <a href="https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200409a2.pdf">purchases of corporate bonds</a> resulted in <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/federal-reserve-takes-flak-for-buying-fossil-fuel-company-bonds-59677632">subsidies to the fossil fuel sector</a>.</p>
<p>Our analysis suggests two ways to help manage climate change now: The Fed can reinterpret its current statutory duties and start viewing climate action as a critical part of its role in maintaining economic stability within its existing mandate, <a href="https://www.ecb.europa.eu/ecb/climate/our_approach/html/index.en.html">as the European Central Bank has done</a>, or the mandate of the Fed can be changed by Congress to explicitly include “green” transformation objectives, similar to the <a href="https://www.manchester.ac.uk/discover/news/facilitating-the-transition-to-net-zero-and-institutional-change-in-the-bank-of-england-perceptions-of-the-environmental-mandate-and-its-policy-implications-within-the-british-state/">U.K.’s mandate for the Bank of England</a>.</p>
<p>Either of these options could empower the Fed <a href="https://neweconomics.org/2022/09/green-credit-guidance">to address climate change</a> and support the government, businesses, banks, households and communities in financing climate mitigation and adaptation efforts.</p>
<figure class="align-center ">
<img alt="Two maps showing extreme heat days rising almost everywhere and extreme precipitation increasingly common, particularly in the Eastern U.S." src="https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=368&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=368&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=368&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=462&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=462&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=462&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Rising temperatures exacerbate climate risks, including droughts, wildfires and extreme storms. Global temperatures have already warmed by more than 1 degree Celsius (1.8 Fahrenheit) compared to preindustrial times. The projected changes with 2 C (3.6 F) of warming, which the world is on pace to exceed this century, are relative to the 1991-2020 average.</span>
<span class="attribution"><a class="source" href="https://nca2023.globalchange.gov/">Fifth National Climate Assessment</a></span>
</figcaption>
</figure>
<p>The Fed could also discourage banks and investors from investing in assets that ultimately harm the economy – for instance, by <a href="https://www.americanprogress.org/article/addressing-climate-related-financial-risk-bank-capital-requirements/">setting collateral requirements</a> for banks that would reduce the <a href="https://www.lse.ac.uk/granthaminstitute/publication/greening-collateral-frameworks/">attractiveness of holding carbon-intensive assets</a>. The European Central Bank recently announced that it would tilt purchases of <a href="https://www.allianz.com/en/economic_research/publications/specials_fmo/2023_06_27_Green-monetary-policy.html">corporate bonds toward “green” assets</a>. </p>
<p>The Fed has recently taken steps to push <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231024b.htm">large financial institutions to monitor climate-related risks</a> in their portfolios, <a href="https://bankingjournal.aba.com/2023/05/senators-criticize-fed-for-engaging-in-climate-activism/">drawing the ire of Republicans</a>, who claimed the bank had no authority to consider climate change. Whether this risk management approach will pressure banks to change their lending patterns is not yet clear.</p>
<p>The Fed and other central banks could go further and <a href="https://rooseveltinstitute.org/publications/supervising-the-transition/">mandate energy transition planning</a> with an eye toward economic stability. The European Union developed a <a href="https://www.ecb.europa.eu/ecb/climate/green_transition/html/index.en.html">whole new sustainable finance framework</a> designed to <a href="https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en">discourage investment</a> in economic activities that do not support an energy transition along the lines of the <a href="https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en">European Green Deal</a>, which aims to turn Europe into a climate-neutral continent with no one left behind. The European Central Bank is obligated to support EU economic policies, including the green transition. </p>
<h2>The Fed has used creative tools before</h2>
<p>Many times in its 110-year history, the Fed has <a href="http://doi.org/10.2139/ssrn.4516824">provided financial support to the U.S. government</a> during major crises, such as wars and recessions, by offering direct lines of credit or by directly purchasing Treasury bonds. During the pandemic, it took extraordinary steps to keep U.S. businesses running.</p>
<p>Now that the U.S. is facing rising costs from the climate crisis, we believe the Fed should treat climate change with the same urgency and importance. </p>
<p>In our analysis of the tools available to central banks, we took a <a href="https://doi.org/10.1007/s40641-022-00186-6">climate justice</a> perspective, looking beyond greenhouse gas emission reductions to incorporate social justice and economic equity. Instead of focusing on supporting corporate interests and the financial sector in the short term to stabilize markets, we believe central banks could <a href="https://www.boeckler.de/pdf/v_2022_10_22_sokol.pdf">prioritize longer-term stability</a> by funneling investments toward vulnerable communities and people.</p>
<p>The <a href="https://eprints.soas.ac.uk/36190/">Bank of England</a>, the <a href="https://www.brookings.edu/wp-content/uploads/2023/08/WP88-DiLeo-et-al.pdf">European Central Bank</a> and other central banks are already implementing some <a href="https://greencentralbanking.com/scorecard/">pro-climate measures</a>. At the Fed, Powell seems more concerned with political backlash than the economic damage to the U.S. economy outlined in the latest climate assessment.</p>
<p>We believe it is past time that the Fed consider climate destabilization as a major economic crisis and use more of the tools in the central bank toolbox to tackle it.</p><img src="https://counter.theconversation.com/content/217979/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jennie C. Stephens is affiliated with the Climate Social Science Network and is a Radcliffe-Salata Climate Justice Fellow at Harvard University for the 2023-2024 academic year. </span></em></p><p class="fine-print"><em><span>Martin Sokol received funding from the European Research Council (ERC) Consolidator Grant No. 683197.</span></em></p>Fed Chair Jerome Powell bristles at talk of managing climate change, but the damage it is doing the US economy is hard to ignore, as the latest National Climate Assessment shows.Jennie C. Stephens, Dean’s Professor of Sustainability Science & Policy, Northeastern UniversityMartin Sokol, Associate Professor of Economic Geography, Trinity College DublinLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2170942023-11-07T05:48:11Z2023-11-07T05:48:11ZWhy it’s a good bet the Melbourne Cup Day rate hike will be the last<p>Australia just became the odd one out.</p>
<p>At its meeting last week, the <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20231101a.htm">US Federal Reserve</a> kept its official interest rate on hold. A week earlier, the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp231026%7E6028cea576.en.html">European Central Bank</a> and the <a href="https://www.bankofcanada.ca/core-functions/monetary-policy/key-interest-rate/">Bank of Canada</a> kept their rates on hold, and, at their meetings before that, the <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023">Bank of England</a> and the <a href="https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/the-official-cash-rate#">Reserve Bank of New Zealand</a> did the same thing.</p>
<p>Throughout the Western world – with perhaps Australia as the only exception – financial markets have been assuming central banks were done with increasing rates and would soon start <a href="https://www.ft.com/content/c7e712e8-12be-4d25-82e5-e53bd3bb3311">pushing them down</a>.</p>
<p>Reserve Bank Governor Michele Bullock’s <a href="https://www.rba.gov.au/media-releases/2023/mr-23-30.html">statement</a> accompanying Tuesday’s hike in Australia’s cash rate makes it look as if we’re about to join that club. It makes it look as if this hike from 4.1% to 4.35% – a 12-year high – will be the last.</p>
<p>And with good reason. Inflation has been falling almost everywhere, and – notwithstanding the recent uptick associated with higher oil prices – is forecast by the International Monetary Fund to keep falling.</p>
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<h2>The RBA has taken out insurance</h2>
<p>So why did Australia’s Reserve Bank push up rates at all, at a time when none of its global peers were? </p>
<p>The statement makes it look as if it wanted to take out insurance.</p>
<p>While the bank still expects inflation to continue to fall, it says progress now looks “slower than earlier expected”.</p>
<p>Its revised set of forecasts, to be released <a href="https://www.rba.gov.au/publications/">on Friday</a>, still have inflation falling, but to around 3.5% by the end of next year, instead of 3.3%, then to around 3% by the end of 2025 instead of <a href="https://www.rba.gov.au/publications/smp/2023/aug/forecasts.html">2.8%</a>.</p>
<p>The bank is particularly worried that the prices of services – things such as service in a cafe, done by hard-to-find workers – are “continuing to rise briskly”. </p>
<p>And it mentions “uncertainties” four times in eight paragraphs. It isn’t that it thinks inflation won’t keep coming down; it’s that it wants to be <em>sure</em> it is.</p>
<h2>Australian hikes hit harder than in the US</h2>
<p>One argument the bank hasn’t used – and nor should it – is catch-up. The US, the UK, the EU, Canada and New Zealand all have higher official rates than Australia.</p>
<p>But they are all are different to Australia, in an important way.</p>
<p>When the US Federal Reserve pushes up its Federal Funds Rate, nothing much happens to US home borrowers. Here’s why: almost all US home borrowers are on <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">fixed rates</a>, meaning their required mortgage payments don’t increase. </p>
<p>In Australia, only about <a href="https://www.rba.gov.au/publications/bulletin/2023/mar/fixed-rate-housing-loans-monetary-policy-transmission-and-financial-stability-risks.html">one-third</a> of home loans are fixed.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Stack of US $100 notes" src="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=965&fit=crop&dpr=1 600w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=965&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=965&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1213&fit=crop&dpr=1 754w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1213&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1213&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">In the US, mortgage rates are fixed for up to the life of the loan.</span>
<span class="attribution"><span class="source">Shutterstock</span></span>
</figcaption>
</figure>
<p>And US fixed rates are nothing like Australian fixed rates. The <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">typical term</a> in the US is 30 years, rather than the two to three years common in Australia.</p>
<p>This means that, as long as borrowers in the US don’t refinance or move homes, their payments are fixed for the entire term of their loans. Americans never have to pay more just because the Fed jacks up rates. </p>
<p>At least when it comes to homebuyers, the US Fed has to do a good deal more than Australia’s Reserve Bank to have the same effect.</p>
<p>It means the US official rate of 5.25% has less immediate effect on ordinary Americans than Australia’s new rate of 4.35% will have on us.</p>
<p>That’s what the consumer spending figures show. </p>
<p>After a year of high US rates, American consumers are buying 2.9% <a href="https://www.census.gov/retail/sales.html"><em>more</em></a> goods and services than they were a year ago. </p>
<p>After a year of less-high Australian rates, Australian consumers are buying 1.7% <a href="https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/sep-2023#"><em>less</em></a>.</p>
<p>This means that, as relatively lightweight as our previous 4.1% cash rate had seemed, it might have been packing more punch than the higher 5.25% rate in the US; and also the higher rates in the UK, Canada and New Zealand, where most of the mortgages are <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">also fixed</a>.</p>
<h2>‘Painful squeeze’</h2>
<p>In her statement, Governor Bullock acknowledged many households were experiencing “<a href="https://www.rba.gov.au/media-releases/2023/mr-23-30.html">a painful squeeze on their finances</a>”. She also noted others were benefiting from rising housing prices, substantial savings buffers and higher interest income. </p>
<p>Bank calculations suggest one in 20 variable-rate borrowers are now going backwards – paying more for essential expenses and housing than they earn. </p>
<p>Among borrowers with big loans relative to their incomes, it’s <a href="https://www.rba.gov.au/speeches/2023/sp-gov-2023-10-24.html">one in four</a>.</p>
<p>There’s nothing in the governor’s statement to suggest she is thinking of pushing up rates again. After today’s hike, the futures market assigned only a <a href="https://www.asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker">30%</a> probability to another hike. </p>
<p>The best guess of people who bet on this for a living is that Australia is about to join the rest of the world and leave rates where they are for quite some time.</p>
<h2>A frugal Christmas, before possible rate drops in 2024</h2>
<p>Alternatively, rates could even begin coming down within 12 months.</p>
<p>The detail of the inflation figures shows monthly inflation surged to 0.8% for one month only, in August, when petrol and diesel prices jumped 9.1%, then fell back to <a href="https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/monthly-consumer-price-index-indicator/latest-release#data-downloads">0.3%</a> in September, which is where it was before petrol prices jumped.</p>
<p>It is also looking like prices scarcely increased at all last month. </p>
<p>The Melbourne Institute inflation gauge, which comes out ahead of the Bureau of Statistics gauge and broadly tracks it, fell 0.1% in October. This suggests that, when taken together, price falls (<a href="https://tradingeconomics.com/australia/mi-inflation-gauge-mom">slightly more than</a>) outweighed price increases.</p>
<p>It’s what you would expect if we were tightening our belts, <a href="https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/sep-2023#">as we are</a>. </p>
<p>At Big W discount department stories across Australia, sales are down <a href="https://cdn-api.markitdigital.com/apiman-gateway/ASX/asx-research/1.0/file/2924-02729605-2A1482720?access_token=83ff96335c2d45a094df02a206a39ff4">5.5%</a> on where they were a year ago. </p>
<p>Big W says shoppers have moved away from buying big-ticket items and are instead buying a <a href="https://www.afr.com/chanticleer/woolies-watching-housing-pain-as-cpi-stokes-rate-rise-fears-20231025-p5eez9">remarkable</a> number of small gifts, such as Hot Wheels toy cars. </p>
<p>They sell for $2 each, or five for $9.</p>
<p>It’s pointing to a frugal Christmas in which retailers are going to have to discount if they want to move goods, taking further pressure off inflation.</p>
<p>Should that happen, rates could turn down even sooner than financial market traders expect, perhaps by the middle of next year.</p>
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Read more:
<a href="https://theconversation.com/petrol-is-holding-up-inflation-the-7-graphs-that-show-whats-happening-to-prices-and-what-it-will-mean-for-interest-rates-215888">Petrol is holding up inflation – the 7 graphs that show what's happening to prices and what it will mean for interest rates</a>
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</em>
</p>
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<img src="https://counter.theconversation.com/content/217094/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin is Economics Editor of The Conversation.</span></em></p>It’ll now be a frugal Christmas in many Australian homes. But there is a glimmer of good news: if we do tighten our belts, rates could start to come down by as early as the middle of next year.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2168362023-11-01T07:45:11Z2023-11-01T07:45:11ZPolitics with Michelle Grattan: Economist Chris Richardson on a likely interest rate rise and the fall in living standards<p>The International Monetary Fund (IMF) released a report this week calling on Australia to raise interest rates again, adding to the speculation the Reserve Bank will increase the cash rate on Tuesday. </p>
<p>If that happens it will be yet another blow to many household budgets, already under strain from the rises in the prices of food, fuel and power. </p>
<p>In this podcast, independent economist Chris Richardson joins The Conversation to discuss the expectations about a rate rise, “sticky” inflation, the fall in the standard of living, the difficulty of the government responding to the cost-of-living crisis, and a bleak prospect as we go into 2024, before we reach some light at the end of a long tunnel.</p>
<p>Asked whether a rate rise next week is virtually a foregone conclusion or whether there’s still some doubt, Richardson says:</p>
<blockquote>
<p>Never say never on something like interest rates. But the new Reserve Bank governor did pretty clearly put a line in the sand and then almost straight away, the inflation numbers seemed to cross that line. So like most economists, I do expect Tuesday […] we’ll see a further rise in interest rates. </p>
</blockquote>
<p>On the issue of living standards in Australia he says: </p>
<blockquote>
<p>I’m surprised that there is not more discussion of arguably the key number in economics, our living standards – basically the amount of money that people have, disposable income. So you take out tax, you take out interest payments, you look at that per head, you put it in today’s prices – that peaked in September ‘21. It was artificially high during COVID, but it is down almost 10% since then. And that fall is rather larger than anything Australia saw in recessions in decades past. </p>
</blockquote>
<p>Asked what can or should the government do about the cost-of-living crisis, Richardson say: </p>
<blockquote>
<p>It can’t do much. When we talk about a cost-of-living crisis, we’re saying that inflation is dragging down our living standards and that that’s a problem. Now, if governments could solve that, not just Australian governments, past governments as well as the current one, other governments around the world, if they had a magic wand, they would have been waving that magic wand pretty madly. They don’t. And that’s the trick.</p>
<p>In current circumstances, if you give people extra money, well, of course they’ll spend it […] and that would simply push inflation up again. And indeed, if the government did enough of that it wouldn’t just push inflation up again, it could make the Reserve Bank raise rates again. In other words, a cost-of-living problem is a wicked one for governments to do something about.</p>
</blockquote><img src="https://counter.theconversation.com/content/216836/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michelle Grattan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In this podcast, independent economist Chris Richardson joins The Conversation to discuss a rate rise, "sticky" inflation, the fall in the standard of living, and a bleak prospect as we go into 2024.Michelle Grattan, Professorial Fellow, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2166532023-10-31T12:56:38Z2023-10-31T12:56:38ZInterest rates: if central banks don’t start cutting them soon, it could actually increase inflation<figure><img src="https://images.theconversation.com/files/556622/original/file-20231030-15-ssa8rd.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Another reason to be fearful. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/businessman-walking-on-abstract-growing-interest-2126771846">Golden Dayz</a></span></figcaption></figure><p>What next for interest rates? The Bank of England’s Monetary Policy Committee (MPC) is <a href="https://www.ft.com/content/2b0dcf95-b4ee-4eee-ad39-a7f5f3fbed3e">widely expected</a> to leave them unchanged when it meets on November 2, despite the fact that UK headline inflation is still at 6.7%. If so, it will mark the second monthly freeze in a row, following 14 consecutive hikes dating back to late 2021. </p>
<p>The main argument for pausing when inflation is still high is that each rise takes time to have full effect. It’s possible that the brakes have already been pressed far enough, and that any <a href="https://www.schroders.com/en-gb/uk/institutional/insights/uk-should-brace-for-6-5-interest-rates-here-s-why-we-ve-raised-our-forecast/">further rate rise</a> could push the economy into recession. The MPC <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023">said as much</a> in its rationale for the September hold. </p>
<p>While higher interest rates subdue inflationary pressure by reducing the amounts that people borrow and spend, households and businesses don’t feel the effect immediately. This is because they have either not borrowed or fixed their interest rates at a lower level. When those fixed-rate periods end, these borrowers will join the many who must already channel more of their income into interest payments, leaving less to buy other things.</p>
<p>The <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">Bank of England (BoE) estimated</a> in January that more than 1.4 million out of the <a href="https://www.ukfinance.org.uk/news-and-insight/press-release/uk-finance-mortgage-data#:%7E:text=There%20are%20a%20total%20of,if%20the%20Bank%20Rate%20rises.&text=There%20are%20a%20total%20of%202%2C033%2C512%20buy%20to%20let%20mortgages,also%20being%20on%20fixed%20rates.">total of 8.5 million</a> mortgage borrowers in the UK would see interest rates jump during 2023, as they move off fixed rates that were mostly below 2%. Another 1.6 million <a href="https://www.theguardian.com/money/2023/jun/17/uk-homeowners-face-huge-rise-in-payments-when-fixed-rate-mortgages-expire#:%7E:text=In%20total%2C%20up%20to%204.4,and%20the%20end%20of%202024.">are also expected</a> to have to remortgage in 2024. Meanwhile, even debt-free businesses will find their income reduced as customers who need credit find it’s costing them more.</p>
<h2>Alternative arguments</h2>
<p>Additional pressures to avoid any further interest rate rises are now evident. <a href="https://www.levyinstitute.org/publications/in-defense-of-low-interest-rates">Some economists doubt</a> that raising rates has had much effect against <a href="https://theconversation.com/inflation-raising-interest-rates-was-never-the-right-medicine-heres-why-central-bankers-did-it-anyway-216087">today’s inflation</a> because it has largely been caused, not by an overheating economy, but by scarcity of goods and commodities due to the Ukraine war and opening up after the pandemic. </p>
<p>Still others point to evidence that rises in interest rates are followed by <em>higher</em> inflation. This has been found in <a href="https://www.nber.org/system/files/working_papers/w23977/w23977.pdf">recent studies</a> of the US and Japan, and some lower-income economies such as <a href="https://intapi.sciendo.com/pdf/10.2478/jcbtp-2018-0019">Brazil and Indonesia</a>. To understand this, you need to grasp a standard economic theory called the “<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3349096">Fisher effect</a>”, named after an early 20th century American economist called <a href="https://en.wikipedia.org/wiki/Irving_Fisher">Irvine Fisher</a>. It suggests that economies have an equilibrium “real” interest rate, measured by the interest rate minus inflation.</p>
<p>For example, if a high-street bank offers one-year loans at 5% and annual inflation jumps from 3% to 5%, the bank has less incentive to lend at the same rate because the amount it gets back at the end of the year will be worth less than before. For the same reason, households and firms are dissuaded from saving. They are reacting to the fact that “real” interest rates have fallen. To keep lending and saving on track – in other words, to keep the economy running as normal – the central bank must raise the headline interest rate. </p>
<p><strong>UK interest rate vs inflation</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing 25 years of inflation and interest rates in the UK" src="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=350&fit=crop&dpr=1 600w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=350&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=350&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=440&fit=crop&dpr=1 754w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=440&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=440&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation (orange) is consumer price inflation. Interest rates (blue) are the Bank of England benchmark rate.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Some of this <a href="https://www.stlouisfed.org/publications/regional-economist/july-2016/neo-fisherism-a-radical-idea-or-the-most-obvious-solution-to-the-low-inflation-problem#fig1">research also suggests</a> there is a two-way causation. Not only do interest rates need to rise in response to inflation, they can also pull inflation upwards – precisely the opposite of what the monetary policymakers intend. This becomes a risk when interest rates are expected to stay high. Businesses then push up their prices, and households raise their wage demands, to cover their increased borrowing costs, and the expectation is fulfilled as central banks are forced to keep rates high. </p>
<p>Rate rises can still be effective if they reduce inflation quickly, allowing them to fall back to previous levels before expectations change. The International Monetary Fund, which often represents the economic mainstream, has <a href="https://www.imf.org/en/Blogs/Articles/2023/04/10/interest-rates-likely-to-return-towards-pre-pandemic-levels-when-inflation-is-tamed">conveyed the view</a> that global interest rates will drop back to pre-pandemic levels once the present inflation wave has passed.</p>
<p>But other experts, including the Bank of England’s chief economist, <a href="https://www.reuters.com/world/uk/boe-will-see-job-through-inflation-pill-says-2023-08-31/">Huw Pill</a>, believe interest rates must stay elevated for a longer time to ensure inflation is crushed. Some even argue that they should now stabilise close to present levels, as a reset from the exceptional 13 years in which they stayed close to zero after the global financial crisis of 2007-09. </p>
<p><strong>UK real interest rates 2000-22</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing real interest rates since 2000" src="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">BoE/ONS</a></span>
</figcaption>
</figure>
<p><a href="https://www.jrf.org.uk/press/interest-rate-hike-will-have-serious-consequences-low-income-families">The risks</a> of keeping interest rates at their present high level extend further than the possibility of causing recession, and worsening misery for the poorest borrowers, without taming inflation. A rise in interest rates means <a href="https://knowablemagazine.org/article/society/2022/the-obscure-calculation-transforming-climate-policy">investors become</a> more short-termist – increasing their focus on immediate costs and putting less value on potential gains further into the future. Especially when we need many billions of dollars of investment to build the green economy, a shortfall caused by high interest rates could have ramifications for the future of the planet.</p>
<p>Besides that concern, production capacity will only grow slowly across the board if investment is choked off. That is likely to be another source of inflationary pressure, if central banks don’t start to reverse the rise in interest rates early next year.</p><img src="https://counter.theconversation.com/content/216653/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>So you thought raising interest rates brought down inflation? The reality is a bit more debatable.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2160872023-10-20T15:24:18Z2023-10-20T15:24:18ZInflation: raising interest rates was never the right medicine – here’s why central bankers did it anyway<figure><img src="https://images.theconversation.com/files/555021/original/file-20231020-17-7s9i1o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Pain, no gain? Bank of England Governor Andrew Bailey. </span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/imfphoto/51589159888/in/photolist-2nwx1ky-2nSrKcw-2nwrLSq-2nSuk8H-2nSwZQq-E2Ve9H-2nSwZRH-2nSrKbu-2nSwFWg-2nSrKjq-2mAKVTW-2k5RZiM-2j6RVqc-2j6Tovo-E2Yqn8-2ngymcQ-ac1Rk-2mAJPT9-2oLaMFA-isobr-2oKXTVq-2oLdiw5-7itq9N-2oL5EJU-2oL5g73-2oL4CcG-2oLagKW-2oLaF8Y-2oLaFam-2oL8f4E-2oLadqz-2oL9ySC-2oL5g8A-2oL6Sve-7ipwbM-2oKWMsg-9JspXi-2oti5Eo-2oti5Dw-isnVx-2noQWwH-isnFy-2noYNVY-7ipwoH-2noYNZa-2noXsQD-2noYNJR-2p8PNcg-2p8Sm3F-2noYNRp">IMF</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>Inflation remains too high in the UK. The annual rate of consumer price inflation to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/september2023#:%7E:text=a%20year%20ago.-,The%20Consumer%20Prices%20Index%20(CPI)%20rose%20by%206.7%25%20in,of%2011.1%25%20in%20October%202022.">September was 6.7%</a>, the same as a month earlier. This is well below the 11.1% peak reached in October 2022, but the failure of inflation to keep falling indicates it is proving far more stubborn than anticipated. </p>
<p>This may prompt the Bank of England’s Monetary Policy Committee (MPC) to raise the benchmark interest rate yet again when it meets in November, but in my view this would not be entirely justified. </p>
<p>In reality, the rate hikes that began two years ago have not been very helpful in tackling inflation, at least not directly. So what’s the problem and is there a better alternative?</p>
<h2>Right policy, wrong inflation</h2>
<p>Raising interest rates is the MPC’s main tool for trying to get inflation back to its target rate of 2%. The idea is that this makes it more expensive to borrow money, which should reduce consumer demand for goods and services. </p>
<p>The trouble is that the type of inflation recently witnessed in the UK seems less a problem of excessive demand than because costs have been rising for manufacturers and service providers. It’s known as “cost-push inflation” as opposed to “demand-pull inflation”. </p>
<p><strong>Inflation rates (UK, US, eurozone)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph comparing inflation rates of UK, US and eurozone" src="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=353&fit=crop&dpr=1 600w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=353&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=353&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=443&fit=crop&dpr=1 754w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=443&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=443&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">UK = dark blue; eurozone = turquoise; US = orange.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Production costs have risen for several reasons. During the COVID-19 pandemic, central banks “created money” through <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">quantitative easing</a> to enable their governments to run large spending deficits to pay for furloughs and other interventions to help citizens through the crisis. </p>
<p>When countries started reopening, it meant <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/mwb7/ukea">people had money</a> in their pockets to buy more goods and services. Yet with China still in lockdown, global supply chains could not keep pace with the resurgent demand so prices went up – <a href="https://tradingeconomics.com/commodity/crude-oil">most notably oil</a>. </p>
<p><strong>Oil price (Brent crude, US$)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing price of Brent crude oil" src="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=346&fit=crop&dpr=1 600w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=346&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=346&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=435&fit=crop&dpr=1 754w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=435&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=435&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Then came the Ukraine war, which further drove up prices of fundamental commodities, such as energy. This made inflation much worse than it would otherwise have been. You can see this reflected in consumer price inflation (CPI): it was <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2020#:%7E:text=The%20Consumer%20Prices%20Index%20(CPI)%2012%2Dmonth%20inflation%20rate,with%200.0%25%20in%20June%202019.">just 0.6%</a> in the year to June 2020, then <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2021">rose to 2.5%</a> in the year to June 2021, reflecting the supply constraints at the end of lockdown. By June 2022, four months after Russia’s invasion of Ukraine, CPI <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2022#:%7E:text=The%20Consumer%20Prices%20Index%20(CPI,of%200.5%25%20in%20June%202021.)">was 9.4%</a>.</p>
<h2>The policy problem</h2>
<p>This begs the question, why has the Bank of England (BoE) been raising rates if it’s unlikely to be effective? One answer is that other central banks have been raising rates. If the BoE doesn’t mirror rate rises in the US and eurozone, investors in the UK may move their money to these other areas because they’ll get better returns on bonds. This would see the pound depreciating against the US dollar and euro, in turn increasing import prices and aggravating inflation. </p>
<p>Part of the problem has been that the US has arguably faced more of the sort of demand-led inflation against which interest rates are effective. For one thing, the US has been less at the mercy of rising energy prices because it is <a href="https://www.eia.gov/energyexplained/us-energy-facts/imports-and-exports.php">energy self-sufficient</a>. It also didn’t lock down as uniformly as other major economies during the pandemic, so had a little more space to grow. </p>
<p>At the same time, the US has been <a href="https://tradingeconomics.com/united-states/inflation-cpi">more effective</a> at bringing down inflation than the UK, which again suggests it was fighting demand-driven price rises. In other words, the UK and other countries may to some extent have been forced to follow suit with raising interest rates to protect their currencies, not to fight inflation. </p>
<h2>What next</h2>
<p>How harmful have the rate rises been in the UK? They have not brought about a <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/august2023">recession yet</a>, but <a href="https://www.statista.com/statistics/941233/monthly-gdp-growth-uk/">growth remains</a> very weak. Lots of <a href="https://www.theguardian.com/business/2023/jun/20/cost-of-living-payments-failing-to-help-low-income-households-in-uk">people are struggling</a> with the cost of living, as well as <a href="https://www.theguardian.com/business/2023/jun/20/cost-of-living-payments-failing-to-help-low-income-households-in-uk">rent or mortgage costs</a>. Several million people are due to be hit by much higher mortgage rates as their fixed-rate deals end between now and the end of 2024. </p>
<p><strong>UK GDP growth (%)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing the annual rate of GDP growth" src="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=348&fit=crop&dpr=1 600w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=348&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=348&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=437&fit=crop&dpr=1 754w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=437&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=437&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>If hiking interest rates is not really helping to curb inflation, it makes sense to start moving in the opposite direction before the economic situation gets any worse. To avoid any damage to the pound, the answer is for the leading central banks to coordinate their policies so that they cut rates in lockstep. </p>
<p>Unless and until this happens, there would seem to be no quick fix available. One piece of good news is that the energy price cap for typical domestic consumption <a href="https://www.ofgem.gov.uk/information-consumers/energy-advice-households/energy-price-cap">was reduced</a> from October 1 from £1,976 to £1,834 a year. That 7% reduction should lead to consumer price inflation coming down significantly towards the end of 2023. </p>
<p>More generally, the Bank of England may simply have to hope that world events move inflation in the desired direction. A key question is going to be whether the wars in Ukraine and Israel/Gaza result in further cost pressures. </p>
<p>Unfortunately there is a precedent for a Middle East conflict leading to a global economic crisis: <a href="https://en.wikipedia.org/wiki/Yom_Kippur_War">following the</a> joint assault on Israel by Syria and Egypt in 1973, Israel’s retaliation prompted petroleum cartel <a href="https://history.state.gov/milestones/1969-1976/oil-embargo#:%7E:text=During%20the%201973%20Arab%2DIsraeli,the%20post%2Dwar%20peace%20negotiations.">OPEC to impose</a> an oil embargo. This led to an <a href="https://www.macrotrends.net/1369/crude-oil-price-history-chart">almost fourfold increase</a> in the price of crude oil. </p>
<p>Since oil was fundamental to the costs of production, inflation in the UK rose to <a href="https://www.macrotrends.net/countries/GBR/united-kingdom/inflation-rate-cpi">over 16%</a> in 1974. There followed <a href="https://www.economicshelp.org/blog/780/unemployment/unemployment-rates-history/">high unemployment</a>, resulting in an unwelcome combination that economists referred to <a href="https://en.wikipedia.org/wiki/Stagflation#:%7E:text=The%20term%20stagflation%20was%20first,monetary%20policy%20in%20controlling%20inflation.">as stagflation</a>. </p>
<p>These days, <a href="https://www.imf.org/en/Blogs/Articles/2022/05/05/lower-oil-reliance-insulates-world-from-1970s-style-crude-shock">global production</a> is in fact <a href="https://ourworldindata.org/grapher/fossil-fuels-share-energy">less reliant on oil</a> as renewables have become a growing part of the energy mix. Nonetheless, an oil price hike would still drive inflation higher and weaken economic growth. So if the Middle East crisis does spiral, we may be stuck with stubborn, untreatable inflation for even longer.</p><img src="https://counter.theconversation.com/content/216087/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Gausden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>We need to start cutting rates, but there’s something that has to happen first.Robert Gausden, Senior Lecturer in Economics, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2139162023-09-27T12:26:31Z2023-09-27T12:26:31ZWhy central banks should stop raising interest rates<p>Mortgage borrowers breathed a sign of relief following <a href="https://www.bbc.co.uk/news/business-57764601">a recent pause</a> in the Bank of England’s 14-month campaign of base rate hikes.</p>
<p>Led by the US Federal Reserve, many of the world’s <a href="https://www.bis.org/statistics/cbpol.htm">major central banks</a>, including the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">European Central Bank</a> (ECB) and the <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">Bank of England</a>, have been hiking their main rates of interest for more than a year in a bid to slow <a href="https://data.oecd.org/price/inflation-cpi.htm">rapid price inflation</a>.</p>
<p><strong>Rising rates</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing rates rising in steps for UK, US and Eurozone but staying level for Japan." src="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=332&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=332&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=332&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=417&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=417&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=417&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Central bank interest rates.</span>
<span class="attribution"><a class="source" href="https://www.bis.org/statistics/cbpol.htm">Bank for International Settlements (BIS)</a></span>
</figcaption>
</figure>
<p>While the ECB increased rates at its September 2023 meeting, the Bank of England has again followed <a href="https://www.reuters.com/markets/rates-bonds/fed-projections-show-if-soft-landing-is-new-baseline-or-baseless-2023-09-20/">the Fed’s latest decision</a> to pause. </p>
<p>There are <a href="https://www.bankofengland.co.uk/monetary-policy/upcoming-mpc-dates">two more opportunities</a> for a UK rise before the end of the year and <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023#:%7E:text=September%20MPC%20decision.-,Market%20pricing,-in%20the%20immediate">financial markets are expecting</a> rates to go from 5.25% to 5.5%. But the outlook for inflation, recession and the labour market – not to mention how the Fed’s rate changes can affect other economies – indicates that, if rates aren’t cut, the current pause should at least last longer than a couple of months.</p>
<p>The <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">ECB’s latest decision</a> to increase its key interest rate by 0.25% was made despite its expectation that Eurozone inflation will continue to fall. The region faces a unique challenge, however. </p>
<p>Although overall inflation is 5.2%, there is a huge gap between its members – from Spain (2.4%) to Slovakia (9.6%). Differences in inflation and growth indicate <a href="https://link.springer.com/book/10.1007/978-3-030-88185-6">incomplete integration</a> of the region, which does not make the ECB’s job of balancing the economy simple.</p>
<p>In other parts of the world, particularly East Asia, inflation has come down very sharply and is expected to remain low. While UK inflation is higher than in the US, Eurozone and Japan, it is also <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">on a downward trajectory</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">How the Bank of England's interest rate hikes are filtering through to your finances</a>
</strong>
</em>
</p>
<hr>
<p>Mortgage rates are already high <a href="https://theconversation.com/why-mortgage-rates-will-not-return-to-recent-lows-any-time-soon-201619">and could stay that way</a>, bankruptcies are <a href="https://theconversation.com/bankruptcy-is-spiking-among-uk-borrowers-but-there-are-debt-relief-options-if-you-are-struggling-financially-213413">spiking</a> and there is a <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">very weak</a> economic outlook. The Bank of England will need to tread carefully to ensure that attempts to lower inflation further do not <a href="https://www.theguardian.com/business/2023/sep/22/uk-recession-risk-mounts-as-higher-rates-weigh-on-firms#:%7E:text=Britain's%20economy%20is%20at%20growing,pandemic%2C%20since%20the%20financial%20crisis.">stall the economy</a>.</p>
<p>The Fed has the most space to relax monetary policy because the US has experienced a sharper decline in inflation. It is now almost level with Japan, which didn’t even rise interest rates. </p>
<p><strong>Inflation rates are slowing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing inflation rates rising and then falling for US, UK, Eurozone and Japan." src="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=285&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=285&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=285&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=359&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=359&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=359&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation rates, January 2021 - August 2023.</span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">OECD</a></span>
</figcaption>
</figure>
<p>After the Fed’s last decision in July, its chairman Jerome Powell indicated that US interest rates, which are currently at a 22-year high, would <a href="https://www.youtube.com/watch?v=oAq-XXpfn1c&cbrd=1">remain high for some time, explaining</a> that “we need to see that inflation is durably down” and that “core inflation is still pretty elevated”.</p>
<p>While “durably down” is a vague measure, <a href="https://www.investopedia.com/terms/c/coreinflation.asp">core inflation</a> (the change in the price of a basket of goods and services, excluding items prone to price spikes such as energy) <a href="https://www.whitehouse.gov/wp-content/uploads/2023/07/June-CPI-Blog_Figure1.png?resize=1822,1280">has come down significantly</a> in the US. It was well below headline inflation (the overall rate for everything measured by the consumer price index) for most of the last two years.</p>
<p>Core inflation usually moves slower than the more volatile headline rate. But an important point that’s been absent from recent rate discussions is the influence of headline inflation on core inflation. Core and headline inflation <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2011/august/headline-inflation-core-convergence/">tend to converge</a> over time, which implies that when the headline rate decreases it will eventually drag on core inflation, causing overall inflation to slow. </p>
<p>As last year’s <a href="https://fred.stlouisfed.org/series/PNRGINDEXM">high energy prices</a> drop out of yearly inflation calculations, headline and core rates should dip further in most countries, including the UK. And the good news for the UK is that its core inflation <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2023">is already coming down</a> – even faster, in fact, than the headline rate.</p>
<h2>Wage watch and recession outlook</h2>
<p>Another reason for central bank caution about further monetary tightening is the weakening labour market outlook. In the US, wage growth has <a href="https://www.atlantafed.org/chcs/wage-growth-tracker">slowed</a> significantly and job vacancies have <a href="https://fred.stlouisfed.org/series/JTSJOL">declined</a>. The latter means that companies will have less need to use high wages to attract candidates. Meanwhile, lower wage growth leaves people with less money to spend, helping to slow price inflation.</p>
<p>In the UK, real wages have <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/september2023">barely left negative territory</a>. Since the beginning of last year, wages were contracting in real terms as inflation remained a lot higher than pay increases.</p>
<p>In both cases, this also implies that the much-feared <a href="https://www.bis.org/publ/bisbull53.pdf">wage-price</a> spiral hasn’t happened.</p>
<p>Of course, using rate rises to slow inflation is a difficult balancing act: hike too much and central banks choke the economy altogether. This is what the US Fed shall be worried about following the appearance of “yield curve <a href="https://www.bloomberg.com/news/articles/2023-09-14/the-bond-market-has-never-sounded-recession-alarms-for-this-long?leadSource=uverify%20wall">inversion</a>” in US bonds. </p>
<p>This is when there is a surge in demand for long-term government bonds versus short-term. An inversion is thought to <a href="https://www.reuters.com/breakingviews/new-economic-rules-shatter-us-bonds-crystal-ball-2023-09-19/#:%7E:text=But%20after%20substantial%20government%20intervention,ball%20is%20all%20but%20shattered.&text=The%20yield%20on%20two%2Dyear%20U.S.%20Treasury%20notes%20has%20been,yield%20curve%20inversion%20since%201980.">indicate</a> an upcoming recession because it shows investors are worried about the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/fed-hopes-for-soft-landing-for-the-us-economy-but-history-suggests-it-wont-be-able-to-prevent-a-recession-182270">Fed hopes for ‘soft landing’ for the US economy, but history suggests it won’t be able to prevent a recession</a>
</strong>
</em>
</p>
<hr>
<p>This is probably why the Fed hasn’t pressed ahead with further tightening at this time. The UK is now seeing similar signs, with economic growth expressed as <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">monthly real GDP</a> estimated to have fallen by 0.5% in July 2023.</p>
<figure class="align-center ">
<img alt="Sign for Bank station and Threadneedle Street in front of the Bank of England building." src="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England is on Threadneedle Street in London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-may-2023-bank-england-city-2312894195">William Barton/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Following the Fed’s lead</h2>
<p>Fed decisions have global consequences. Research shows its monetary policy decisions have <a href="https://www.federalreserve.gov/econres/notes/feds-notes/international-spillovers-of-tighter-monetary-policy-20221222.html">spillover effects</a> on the rest of the world in terms of the impact of a rate rise on exchange rates and the long-term cost of borrowing. </p>
<p>If the Bank of England, the ECB and other central banks overreact to these spillover effects on their own economies, they may over-tighten monetary policy (that is, raise rates too high) and trigger a recession. </p>
<p>Central banks seem to have been in a race to the top when it comes to rate rises. The US has been setting the pace so it might be time for Fed-led tightening cycle to stop because elevated interest rates are not helping the global economy.</p><img src="https://counter.theconversation.com/content/213916/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central banks balance different factors when raising rates – or not – including inflation and the labour market. But what other countries are doing also has an effect.Muhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2141672023-09-25T15:47:12Z2023-09-25T15:47:12ZInflation: I’ve been analysing the Bank of England’s forecasts over the past two years – here’s how they got it wrong<p>The Bank of England (BoE) has been <a href="https://www.independent.co.uk/business/bank-of-england-admits-it-made-errors-in-uk-inflation-forecasts-b2344105.html">strongly criticised</a> for failing to predict the surge in inflation. Had it done so, it could have reacted more quickly and prevented inflation from rising <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">as high as 11%</a> in autumn 2022. </p>
<p>The bank acknowledges this failing and <a href="https://www.bankofengland.co.uk/news/2023/july/ben-bernanke-to-lead-review-into-forecasting-at-bank-of-england">has asked</a> former Federal Reserve chairman Ben Bernanke to lead a review of its forecasting models for both inflation and GDP growth.</p>
<p>I’ve been doing my own analysis of the BoE’s record by comparing how it has performed relative to other forecasting models. This demonstrates the scale of the bank’s failing – and it turns out to have been compounded by a second error that may have made the situation worse. </p>
<h2>Different forecasting models</h2>
<p>The bank is not completely transparent about how it forecasts inflation, drawing on a number of in-house <a href="https://www.bankofengland.co.uk/working-paper/2013/the-boes-forecasting-platform-compass-maps-ease-and-the-suite-of-models#:%7E:text=The%20platform%20consists%20of%20four,and%20EASE%2C%20a%20user%20interface.">mathematical models</a>. It also factors in market expectations of interest rates and the bank’s judgement of where variables such as energy prices and the pound are heading. In my analysis, I refer to this as <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/august-2023">model 1</a>.</p>
<p>As for the alternatives, model 2 is called a <a href="https://en.m.wikipedia.org/wiki/Quantile_regression">“quantile” model</a>. It incorporates three elements: a measure of whether the economy is overheating, known as the <a href="https://www.imf.org/external/pubs/ft/fandd/2013/09/basics.htm#:%7E:text=The%20output%20gap%20is%20an,that%20is%2C%20at%20full%20capacity.">output gap</a>; the history of inflation; and the effect of quantitative easing (QE), in which central banks have tried to stimulate their economies by “creating” money. </p>
<p>Model 3, known as an <a href="https://en.wikipedia.org/wiki/Vector_autoregression#:%7E:text=A%20VAR%20model%20describes%20the,k%20%C3%97%201)%2Dmatrix">econometric vector autoregressive (VAR)</a> model, seeks to fully capture international effects on the UK economy. It looks at the interactions between pressures in the <a href="https://www.newyorkfed.org/research/policy/gscpi#/overview">global supply chain</a>, the output gap, inflation and the Bank of England benchmark <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">interest rate</a>. It also incorporates <a href="https://fred.stlouisfed.org/series/WTISPLC">oil prices</a> and <a href="https://www.matteoiacoviello.com/gpr_country.htm">global geopolitical risk</a>, which tends to be be ignored by forecasting models. </p>
<p>Meanwhile, model 4 is a lot simpler, looking purely at the history of inflation to predict where it’s heading (we call this an <a href="https://en.wikipedia.org/wiki/Autoregressive_model">autoregressive (AR) model</a>). </p>
<p>I’ve calculated what each model would have predicted for inflation between 2008 and 2023. I’ve also calculated a median showing the combined predictions of the models, since <a href="https://doi.org/10.1016/j.jimonfin.2014.02.006">this often improves</a> results. For the sake of simplicity, I’ve focused on short-term forecasts, meaning those that predict for the coming three months (in other words, one quarter ahead). Looking at the bank’s short-term forecasting is important since this relates closely to its medium-term forecasts. </p>
<h2>How they compare</h2>
<p>The table below ranks these predictions based on a statistical test called the <a href="https://eviews.com/help/helpintro.html#page/content/series-Forecast_Evaluation.html">root mean squared error</a>: the closer to a score of zero, the more accurate the model. </p>
<p><strong>Inflation model accuracy</strong></p>
<p>Over the entire 15-year period, the BoE forecasts actually top the table. The median is only marginally behind in second place, followed by model 2. </p>
<p>Yet when you focus on the past two years, the period that really matters because inflation has been so high, a different picture emerges. Now, first place goes to model 3, whereas the BoE predictions fall to third place. </p>
<p>You get further insights by viewing the predictions in graph form against the path of inflation:</p>
<p><strong>UK inflation predictions 2021-23</strong></p>
<p>This demonstrates the bank’s under-predicting of inflation in 2021 (red line vs black line) – particularly compared to the international VAR model, in yellow. </p>
<p>It also shows the bank substantially <em>over-predicted</em> peak inflation in the final quarter of 2022, expecting 13.1% when it came in at 10.8%. After making that prediction in August 2022, the bank raised the benchmark interest rate by 0.5 points when it had previously only been raising at 0.25 points. It then raised by 0.5 points in September and by 0.75 points in November. </p>
<p>Without this over-prediction, the bank may not have sanctioned such panic rises. This would have put less pressure on the public and potentially made it <a href="https://www.livemint.com/news/india/uk-to-slip-into-recession-before-2024-end-heres-what-we-know-11691594594360.html">less likely</a> that the UK will tip into recession in the coming months. </p>
<p>The next graph plots the models’ inflation predictions since 2008. It shows the BoE considerably under-predicted inflation after initiating QE in 2009, raising questions about its understanding of the impact of the policy. Note that model 2, which attempts to take QE into account, did a much better job in that period, whereas it was one of several occasions when model 3 was less accurate. </p>
<p><strong>UK inflation predictions 2008-23</strong></p>
<h2>Thoughts for the future</h2>
<p>The <a href="https://www.ons.gov.uk/economy/inflationandpriceindices">latest inflation data</a>, published on September 20, point to 6.8% inflation in the third quarter of 2023. I’ve included this in the first graph above, and you can see that the BoE’s forecasts from a few months ago predict this fairly well, as does model 3 (the other models are over-predicting). </p>
<p>Be that as it may, the key point is that to predict inflation accurately, it is important to forecast from different models and to combine forecasts. Relying on a single forecast can often mislead and does no favours to the economics profession. The bank does publish a <a href="https://www.bankofengland.co.uk/quarterly-bulletin/1998/q1/the-inflation-report-projections-understanding-the-fan-chart">fan chart</a> that shows the probability that inflation will be above or below particular values, but this doesn’t always make things better: when it predicted 13.1% inflation for the final quarter of 2022, it attached a 50% probability to inflation being even higher. </p>
<p><strong>Bank of England inflation fan chart</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Bank of England inflation forecast" src="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=259&fit=crop&dpr=1 600w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=259&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=259&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=325&fit=crop&dpr=1 754w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=325&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=325&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/monetary-policy-report/2023/august-2023">Bank of England</a></span>
</figcaption>
</figure>
<p>So where do we go from here? The BoE could pioneer being open about its inflation model and holding a “<a href="https://www.ft.com/content/7601c239-72e7-4b55-8030-5f240555a4a9">prediction tournament</a>” in which the model’s effectiveness would be measured against rivals. </p>
<p>This open-sourcing of forecasting is not a new idea. In the 1980s and 1990s <a href="https://warwick.ac.uk/fac/soc/economics/staff/academic/wallis/">Professor Kenneth Wallis</a> of the University of Warwick used to run an <a href="https://warwick.ac.uk/fac/soc/economics/research/centres/esrc/more/">annual conference</a> for the Economic and Social Research Council, the leading funder of academic economic research. Its aim was to assess the economic forecasting models of various institutions including HM Treasury, BoE, London Business School and the National Institute of Economic and Social Research. </p>
<p>Afterwards, his research team published a report comparing each model. Sadly, this brainstorming activity was discontinued in 1999. As part of his review into the BoE’s forecasting, Ben Bernanke could start by suggesting this annual conference be revived, possibly to be held at the bank itself.</p><img src="https://counter.theconversation.com/content/214167/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Costas Milas has received in the past funding by the Bank of England to work, as the principal investigator, on the project Liquidity and Output Growth in the UK. Costas Milas has received in the past ESRC funding as the principal organiser of an ESRC Seminar Series on Nonlinearities in Economics and Finance.</span></em></p>The bank’s review into its failure to predict the inflation surge misses a second equally important blunder a few months later.Costas Milas, Professor of Finance, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2140222023-09-21T01:31:39Z2023-09-21T01:31:39ZThe Federal Reserve held off hiking interest rates − it may still be too early to start popping the corks<figure><img src="https://images.theconversation.com/files/549439/original/file-20230920-17-gxfnbp.jpg?ixlib=rb-1.1.0&rect=0%2C35%2C5883%2C3880&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Federal Reserve Board Chair Jerome Powell is watching the data.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/federal-reserve-board-chairman-jerome-powell-speaks-during-news-photo/1692581089">Chip Somodevilla/Getty Images</a></span></figcaption></figure><p>Federal Reserve officials <a href="https://www.google.com/search?q=fed+holds+rates">held interest rates steady</a> at their monthly policy meeting on Sept. 20, 2023 – only the second time they have done so since embarking on a rate-raising campaign a year and a half ago. But it is what they hinted at rather than what they did that caught many economists’ attention: Fed officials indicated that they don’t expect rates to end 2023 higher than they predicted in June – when they last issued their projections.</p>
<p><iframe id="QLOD5" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/QLOD5/2/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Since the hiking cycle began, observers have worried about whether increased rates could push the U.S. economy into a downturn. Some have even speculated that <a href="https://theconversation.com/is-the-us-in-a-recession-well-that-depends-on-whom-you-ask-and-what-measure-they-use-187894">a recession had already begun</a>. However, the economy has been more resilient than many expected, and now many economists are wondering whether the seemingly impossible <a href="https://www.brookings.edu/articles/what-is-a-soft-landing/">soft landing</a> – that is, a slowdown that avoids crashing the economy – has become a reality. </p>
<p><a href="https://scholar.google.ch/citations?user=VxWst50AAAAJ&hl=en">As a finance professor</a>, I think it’s premature to start celebrating. <a href="https://www.bls.gov/cpi/">Inflation</a> is still <a href="https://www.bea.gov/news/2023/personal-income-and-outlays-july-2023">almost double</a> the Federal Reserve’s <a href="https://www.federalreserve.gov/faqs/economy_14400.htm">target of 2%</a>, and it is expected to come in at <a href="https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting">around 4%</a> for September. What’s more, the economy is still growing quite fast, with consensus forecasts showing gross domestic product will rise by <a href="https://www.atlantafed.org/cqer/research/gdpnow">nearly 3% this quarter</a>. Some early data suggests that could be <a href="https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/realgdptrackingslides.pdf">a low estimate</a>.</p>
<h2>What’s next for interest rates?</h2>
<p>Fed watchers are parsing every word from the central bank to determine whether another hike is coming this year or next, or if the cycle is truly over. To understand that decision, it helps to consider the bigger picture.</p>
<p>While the U.S. economy has certainly avoided a downturn for longer than many expected, the inflation battle is a long way from finished. In fact, this <a href="https://www.wsj.com/economy/central-banking/why-a-soft-landing-could-prove-elusive-3d17e134">wouldn’t be the first time</a> the economy looked like it would avoid a soft landing. For the next several months, the economy is <a href="https://kalshi.com/markets/govshut/government-shutdown#govshut-23oct02">not likely to implode</a> without a <a href="https://theconversation.com/us-regulators-avoided-a-banking-crisis-by-swift-action-following-svbs-collapse-but-the-cracks-it-exposed-continue-to-weaken-the-global-financial-systems-foundation-201724">major</a> <a href="https://theconversation.com/fed-faces-twin-threats-of-recession-and-financial-crisis-as-its-inflation-fight-raises-risks-of-both-193704">spark</a>.</p>
<p>However, inflation may not continue to fall as quickly in the coming year, which means the Fed may still raise rates more than <a href="https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html">some expect</a>. If rising oil prices continue to <a href="https://www.axios.com/2023/09/13/cpi-report-inflation-august-2023">boost transportation costs</a>, other goods could also get more expensive, which may mean higher interest rates for longer.</p>
<h2>Is this really the end?</h2>
<p>Though Federal Reserve Chair Jerome Powell seemed to indicate that the committee is approaching the end of the hiking cycle, <a href="https://www.kentclarkcenter.org/wp-content/uploads/2023/09/RESULTS-2023-09-13-Survey-10.pdf">only 10%</a> of economists expect that it is over at this point – not that economists’ <a href="https://www.vox.com/2014/12/18/7414973/economists-predictions-treasury">track record of forecasting rates</a> is great either. This is largely because Powell has been clear that the Fed is <a href="https://www.pimco.com/en-us/insights/blog/fed-cycle-enters-data-dependence-phase/">basing its decisions on economic data</a>, which has been strong so far and hopefully will continue in that direction.</p>
<p>So while everyone is watching the Fed this week, they should also keep an eye on broader economic conditions. With luck, the reported data will continue to be strong enough to avoid a downturn, but not so strong that inflation picks back up.</p><img src="https://counter.theconversation.com/content/214022/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>D. Brian Blank does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>News of a soft landing may be premature.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2122142023-09-04T15:33:57Z2023-09-04T15:33:57ZIs the US banking crisis over?<p>The <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">US banking crisis</a> triggered worries about the global banking system earlier in the year. Three mid-sized US banks, Silicon Valley Bank, Silvergate and Signature, fell in quick succession, driving down bank share-prices across the world. </p>
<p>America’s central bank, the Federal Reserve, <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm">made significant amounts</a> of cash available to the failed banks and created a lending facility for other struggling institutions. This calmed investors and prevented immediate contagion, with only one more US regional bank, <a href="https://www.forbes.com/sites/dereksaul/2023/05/01/first-republic-bank-failure-a-timeline-of-what-led-to-the-second-largest-bank-collapse-in-us-history/">First Republic</a>, collapsing a few weeks later. </p>
<p>Yet it’s far from clear whether the crisis is really over. As traders return from their summer holidays to a period <a href="https://www.bbc.co.uk/news/business-30793329">commonly associated</a> with upheaval in the markets, how are things likely to play out?</p>
<h2>Tight margins and dwindling deposits</h2>
<p>Central banks have continued to increase interest rates to counter sustained inflation in recent months. In July, the Fed raised its key interest rate to <a href="https://www.nbcnews.com/business/economy/interest-rate-hike-july-2023-how-much-higher-federal-reserve-rcna96210">as much as 5.5%</a>, the highest in 20 years. The rate was near zero as recently as February 2022. </p>
<p>Though the increases have slowed this year, such a sudden change can be <a href="https://theconversation.com/the-european-central-bank-seems-to-have-got-away-with-raising-interest-rates-in-the-middle-of-a-banking-crisis-heres-why-202052">very harmful</a> for banks – <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4304896">particularly</a> as part of the sort of U-shaped movement in rates that we have seen since the global financial crisis of 2007-09. </p>
<p><strong>US benchmark interest rate, 2007-23</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US benchmark interest rates over the past 15 years" src="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=266&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=266&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=266&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=335&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=335&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=335&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://fred.stlouisfed.org/series/FEDFUNDS">St Louis Federal Reserve</a></span>
</figcaption>
</figure>
<p>Raising rates reduces the value of banks’ assets, increases what they have to pay to borrow, limits their profitability and generally increases their vulnerability to adverse events. Especially in the first half of 2023, banks have had to cope with low loan growth and high deposit costs, meaning the amount they have to pay out in relation to customers’ deposits. </p>
<p>This increased cost is partly because lots of customers have been withdrawing their money and putting it into places where they can make more interest, such as <a href="https://www.forbes.com/uk/advisor/investing/best-money-market-funds/">money market funds</a>. It forced banks to borrow more from the Fed to ensure they have enough money, and at rates much higher than they used to be. </p>
<p>This was one of the reasons for the banking collapses in the spring, destabilising them at a time when the value of the debt on their balance sheets had also fallen sharply. This saw more customers at other banks withdrawing deposits for fear that their money wasn’t safe either. In sum, US banks saw deposits declining between June 2022 and June 2023 <a href="https://fred.stlouisfed.org/series/DPSACBW027SBOG">by almost 4%</a>. Together with higher interest rates, this is generally bad news for the banking sector. </p>
<p>You can see the effect on banks’ profitability by looking at overall net interest margins (NIMs). These are a measure of what banks receive in interest income minus what they pay out to depositors and other funders. </p>
<p><strong>US banks’ net interest margins (%)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US banks' net interest margins" src="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=320&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=320&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=320&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=402&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=402&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=402&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Based on 641 banks.</span>
<span class="attribution"><a class="source" href="https://www.spglobal.com/marketintelligence/en/solutions/sp-capital-iq-pro">S&P Capital IQ</a></span>
</figcaption>
</figure>
<h2>Credit rating downgrades</h2>
<p>The ratings agencies have added further pressure. In early August, <a href="https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-01-08-2023#:%7E:text='%3B%20Outlook%20Stable-,Fitch%20Downgrades%20the%20United%20States'%20Long%2DTerm%20Ratings%20to%20',from%20'AAA'%3B%20Outlook%20Stable&text=Fitch%20Ratings%20%2D%20London%20%2D%2001%20Aug,AA%2B'%20from%20'AAA'.">Fitch downgraded</a> its rating of US government debt to AA+ from AAA. It cited a likely deterioration in the public finances over the next three years and the endless politicking around the debt ceiling, which is the maximum level that the government can borrow. </p>
<p>Sovereign downgrades often reflect problems in the wider economy. This can destabilise banks by making them seem less creditworthy, leading their credit ratings to be downgraded too. That can make it harder for them to <a href="https://academic.oup.com/rfs/article-abstract/29/7/1709/2607032?redirectedFrom=fulltext">borrow money</a> from the markets or potentially even from the Fed. This can then have knock-on effects <a href="https://www.sciencedirect.com/science/article/pii/S0378426617302066">in reducing</a> banks’ lending capacity, capital buffers for coping with bad debts, overall profitability and <a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/jmcb.12080">share prices</a>. </p>
<p><strong>US banks’ share prices 2023</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US banks' share prices in 2023" src="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=347&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=347&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=347&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=436&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=436&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=436&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Bank of America = blue; Citigroup = orange; Goldman Sachs = pale blue; JP Morgan = yellow; Morgan Stanley = indigo; Regional banks = purple.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p>Sure enough, a week after the Fitch announcement, <a href="https://www.reuters.com/business/finance/us-bank-stocks-slide-after-moodys-ratings-downgrade-2023-08-08/">Moody’s downgraded</a> the credit ratings of ten US mid-sized banks, citing growing financial risks and strains that could erode their profitability. It also warned that larger banks including Bank of New York Mellon and State Street were at risk of a future downgrade. </p>
<p>The other major ratings agency, S&P Global Ratings, has <a href="https://www.cnbc.com/2023/08/22/sp-downgrades-multiple-us-banks-citing-tough-operating-conditions.html">since followed suit</a>, while <a href="https://www.dailymail.co.uk/yourmoney/savings-and-banking/article-12409057/How-safe-bank-Fitch-warns-downgrade-dozens-firms-including-JPMorgan-Chase-Bank-America.html">Fitch is threatening</a> to do likewise. <a href="https://openaccess.city.ac.uk/id/eprint/28220/1/Kladakis_Skouralis_2022_CBR.pdf">Our research</a> suggests bank downgrades are associated with making them riskier and more unstable, particularly when accompanied by a sovereign downgrade. </p>
<p>Having said all that, there are positives for US banks. Both interest rates and bank deposits are at least <a href="https://www.fitchratings.com/research/banks/us-banks-deposit-challenges-to-pressure-profitability-credit-capital-09-05-2023">projected to</a> stabilise in the coming months, which should help the sector. Despite the overall decline in banks’ profitability, <a href="https://www.reuters.com/business/finance/us-banks-shares-spark-after-interest-income-boost-outlook-mixed-2023-07-18/">bigger banks</a> are reporting improved margins from charging higher interest on loans. Some of these banks also expect a boost from things like increased deal-making later in the year. Signs like those could help to bring more stability across the board. </p>
<p>In Europe, banks have seen <a href="https://www.ceicdata.com/en/indicator/european-union/total-deposits">reduced deposits</a> and <a href="https://data.ecb.europa.eu/data/datasets/SUP/SUP.Q.B01.W0._Z.I2120._T.SII._Z._Z._Z.PCT.C">net interest margins</a> in recent years, which helps to explain why <a href="https://edition.cnn.com/2023/04/24/investing/credit-suisse-bank-withdrawals-total/index.html">Credit Suisse</a> needed to be rescued by fellow Swiss bank UBS in March. Yet European deposits and profit margins have been recovering in the most recent couple of quarters. At the same time, the European Banking Authority’s recent <a href="https://www.ft.com/content/c6dbb3bf-2c41-4f4a-a178-1068ff704f28">stress tests</a> concluded that large EU banks are robust. </p>
<p>UK banks appear to be in a slightly worse condition than EU banks. They remain resilient on their balance sheets, but their <a href="https://www.ceicdata.com/en/indicator/united-kingdom/total-deposits#:%7E:text=in%20Jun%202023%3F-,United%20Kingdom%20Total%20Deposits%20was%20reported%20at%204%2C428.207%20USD%20bn,table%20below%20for%20more%20data.">deposits have not</a> recovered to quite the same extent as in Europe. They <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/uk-lenders-rejig-net-interest-margin-targets-as-central-bank-rate-hikes-continue-77193182">have also been</a> adjusting down their profit forecasts in anticipation of further rate hikes by the Bank of England.</p>
<h2>Regulatory intervention</h2>
<p>To strengthen the US sector, the regulators <a href="https://www.ft.com/content/d4d15a2a-1568-47db-bd29-937a478dc768">are planning</a> to further increase the minimum levels of capital that must be held by large US banks (with assets worth more than US$100 billion (£79 billion)). </p>
<p>These plans to increase banks’ capacity to absorb losses are encouraging, though will take more than four years to fully implement. The <a href="https://www.bis.org/publ/bcbsca.htm">Basel II</a> international banking rules were introduced to a similar end in 2004, but were not implemented in time to prevent the global financial crisis. </p>
<p>For the moment, the US banking system remains vulnerable both to shocks within the financial system and more general calamities. It will still be a few months before we can say with confidence that the worst is over.</p><img src="https://counter.theconversation.com/content/212214/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A swift intervention by the US Federal Reserve has kept most banks on their feet, but September/October is often the time when financial crises come to a head.George Kladakis, Lecturer in Financial Services, Edinburgh Napier UniversityAlexandros Skouralis, Research Assistant, Bayes Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2125512023-08-30T15:13:33Z2023-08-30T15:13:33ZCentral banks say interest rates will stay high but it’s unclear if this will be enough to curb inflation<figure><img src="https://images.theconversation.com/files/545512/original/file-20230830-21-i0qm7l.jpg?ixlib=rb-1.1.0&rect=0%2C223%2C4019%2C2414&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central bankers, policymakers and academics meet annually at Jackson Hole, Wyoming to discuss the economy.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/jackson-hole-wyoming-landscape-photos-2276541363">Sarah Hollemans/Shutterstock</a></span></figcaption></figure><p>The US central bank, the Federal Reserve, has recently signalled that it will keep interest rates high for as long as it takes to bring inflation down to its 2% target. </p>
<p>Other major central banks, such as the UK’s Bank of England and the European Central Bank (ECB), are likely to follow suit. But rate-setters face some dilemmas when it comes to balancing the use of interest rates to slow the economy versus the risk of a recession.</p>
<p>In an August 25 speech during <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">the annual Jackson Hole Symposium</a>, an <a href="https://www.nytimes.com/2023/08/24/business/economy/jackson-hole-economic-conference.html#:%7E:text=High%20on%20its%20list%20of,Fed%20event%20of%20the%20year.">influential summer gathering</a> of central bankers, policymakers and academics, chairman Jerome Powell indicated that the Fed is not yet convinced it has won the battle against inflation. This is despite the <a href="https://www.usinflationcalculator.com/inflation/current-inflation-rates/">US headline rate of inflation</a> falling from 8.5% in March 2022 (when the Fed started raising rates) to 3.2% in July.</p>
<p>Powell did suggest the central bank might start to slow the pace of rate rises after <a href="https://www.reuters.com/markets/rates-bonds/fed-poised-hike-rates-markets-anticipate-inflation-endgame-2023-07-26/#:%7E:text=The%20hike%2C%20the%20Fed's%2011th,exceeded%20for%20about%2022%20years.">11 consecutive rises</a> in interest rates to 5.5% in little more than a year. As in other regions, such as the UK and EU, recent rapid increases have reversed around <a href="https://www.macrotrends.net/2015/fed-funds-rate-historical-chart">a decade of ultra-low rates</a>. </p>
<p>This leads to even higher interest rates being charged by financial institutions, and so is designed to slow the economy. But if taken too far, it could also trigger a recession.</p>
<p>The Jackson Hole meeting is closely watched by financial markets, governments and the media for indications of the long-term direction of monetary policy, and for deeper insights into the challenges facing the world’s central banks. And so the speech was <a href="https://edition.cnn.com/business/live-news/markets-jackson-hole-fed-meeting/index.html#:%7E:text=Stocks%20fall%20as%20traders%20digest,and%20the%20Nasdaq%20dropped%200.3%25.">a disappointment to financial markets</a>, which have been rocked by recent sharp interest rates hikes. </p>
<p>For more than a decade, stock markets boomed on the back of near-zero interest rates, with the US Dow Jones Industrial Average (DJIA) <a href="https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart">quadrupling</a>. But as the Fed started raising rates, the DJIA plummeted by 20%, with a short-lived recovery that soon fizzled out. And so, market hopes for a rate cut this year have been dashed – although Powell did suggest that how far and how fast rates would rise remains up for debate. </p>
<p>Indeed, Powell warned of the potential for more pain to come for households and businesses either way. Reducing inflation inevitably leads to below-trend economic growth, which causes companies to reduce pay and hiring activity. Outlining central banks’ current balancing act, <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">he said</a>: “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”</p>
<p>Similar sentiments were <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230825%7E77711105fe.en.html">echoed by ECB president Christine Lagarde</a> at Jackson Hole. The Eurozone is also in the middle of sharply raising interest rates, despite slumping economic growth. While Largarde emphasised that the ECB must aim to keep inflation at 2% in the medium term, she also said: “There is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one.”</p>
<p>Indeed, it remains to be seen if the world economy is entering a new phase of high inflation and weak growth, or whether the conditions that have led to the recent inflationary surge are temporary.</p>
<h2>Are we in a new economic era of high inflation?</h2>
<p>At Jackson Hole, Powell highlighted the need to ensure that public expectations of continued rapid inflation do not become entrenched. This could trigger a wage-price spiral that could get out of control. He warned that the cost of inaction would, therefore, be even higher.</p>
<p>Indeed, all of the major central banks, including the Fed, dramatically underestimated the effect of the pandemic on inflation. They have been <a href="https://www.reuters.com/world/uk/ex-officials-say-bank-england-was-too-slow-heed-inflation-warnings-2023-07-05/">criticised for not acting in time</a> and are now scrambling to rapidly increase interest rates. But why didn’t the central banks’ economic forecasting models predict rising inflation?</p>
<p>Gita Gopinath, the IMF deputy director, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9090/Remarks_by_Gopinath.pdf">argued at Jackson Hole</a> that central bank models are outdated because they underestimated the long-term effects of supply-side disruptions. She suggested that recent failures to stop inflation rises fast enough have seriously damaged central banks’ credibility. As a result, they can no longer hope to ignore short bursts of inflation without serious consequences. She also raised the possibility that, in the long term, weaker economic growth might indeed be the price of curbing inflation.</p>
<p>Several policymakers, including Barack Obama’s former economic adviser Jason Furman, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9674/JH2022_Furman.pdf">also in attendance at Jackson Hole</a>, have even suggested that revising central banks’ target rate of inflation to 3% from 2% would be no bad thing. This is still heresy for most central bankers, who believe making such a significant change to their remit would damage their credibility even more.</p>
<h2>Dilemmas facing central banks</h2>
<p>The Jackson Hole meeting highlighted three key dilemmas for central banks.</p>
<p>First, is the medicine (rate rises) working? While inflation has fallen, core rates in the UK, EU and US are still well above the 2% target. It’s unclear whether slowing demand in the economy is the right approach when inflation has been caused by “supply-side disruption” (pandemic-era supply shortages and the commodity-related effects of Russia’s invasion of Ukraine left too much money chasing too few goods). </p>
<p>And since higher interest rates <a href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2023/february/expectations-lags-and-the-transmission-of-monetary-policy-speech-by-catherine-l-mann.pdf">can take up to 18 months to work</a>, it is hard to judge yet whether economic growth has slowed enough due to higher rates.</p>
<p>Second, it’s unclear how much more economic pain it will take to contain inflation. This question is particularly acute for the ECB and the Bank of England – economic growth in the EU and UK has been much more anaemic and inflation higher than in the US.</p>
<p>Finally, central banks face real challenges in trying to restore their credibility. Given major uncertainty about the future of the world economy, they face the unenviable task of either taking a wait-and-see approach until trends are clearer, or taking pre-emptive action to re-assert their credibility and prevent the worst if inflation remains persistent. </p>
<p>As the global economy cools, particularly driven by recent <a href="https://www.vox.com/world-politics/2023/8/29/23845841/chinas-economy-xi-expert">weak economic growth in China</a>, these trade-offs will only become harder to make.</p><img src="https://counter.theconversation.com/content/212551/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Schifferes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The world’s central banks face a range of dilemmas, not least whether high inflation – and therefore high interest rates – will become permanent.Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2104662023-08-23T20:07:47Z2023-08-23T20:07:47ZHigh interest rates are not bad news for everyone. Just ask savers, importers and Australians heading overseas<figure><img src="https://images.theconversation.com/files/541857/original/file-20230809-28-od1v06.jpg?ixlib=rb-1.1.0&rect=327%2C0%2C9134%2C6260&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/solar-panel-money-investment-house-roof-2214389269">Shutterstock</a></span></figcaption></figure><p><em>This article is part of The Conversation’s series examining Australia’s cost of living crisis. You can read the other articles in the series <a href="https://theconversation.com/au/topics/cost-of-living-series-144357">here</a>.</em></p>
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<p>It is a universally acknowledged truth that interest-rate rises are always a bad thing for the average Australian household.</p>
<p>They are just a punitive form of economic medicine we have to take from time to time, on the say-so of the Reserve Bank of Australia - but nobody enjoys it. Except perhaps the sadistic central bankers.</p>
<p>And this is probably true for anybody with a mortgage. That might describe the majority of economic commentators, but it is not true of all Australians.</p>
<p>While higher interest rates are bad for borrowers, and therefore good for savers, there are in fact many ways higher interest rates directly help (a subset of) Australian households.</p>
<h2>Higher cash rates means lower house prices</h2>
<p>One of the most direct effects of the higher cash rate is its impact on households’ ability to finance the purchase of a new house. Whether you are a first home buyer, a repeat buyer or an investor, a higher interest rate will limit what you can borrow and therefore the amount you’re able to pay.</p>
<p>Accordingly, a higher cash rate leads to lower house prices. This is great news for young Australians yet to buy their first home.</p>
<p>Buying into the property market is especially hard in Australia these days, and lower housing prices is great news for these households who have up until now been locked out of owning a home.</p>
<p>A higher cash rate means they will pay more on their mortgage if they are successful. But the Reserve Bank’s calculations suggest that in the medium term home buyers are better off when higher rates lower house prices.</p>
<h2>The higher the rate, the healthier the returns</h2>
<p>Whether you are saving to buy a car, a house or just for retirement, a higher interest rate will mean you get more bang for your buck on your deposits at the bank. For anyone who has yet to take on a mortgage or has already paid theirs off, higher interest rates mean they will be better placed to build their savings.</p>
<p><a href="https://www.rba.gov.au/publications/rdp/2016/2016-12.html">Analysis of HILDA data</a> by the Reserve Bank suggests these net-savers are less likely to own a home, less likely to be employed, and consume far less than their debt-ridden cousins.</p>
<p>While there is a lot of heterogeneity in the broad category of “savers”, we should welcome the extra income to young households who haven’t yet been fortunate enough to be burdened with a million-dollar mortgage.</p>
<p>While a lot of Australians invest their savings in the stock market either directly or indirectly via their superannuation funds, many retirees transfer their assets to less volatile forms of savings such as term deposits or cash savings. A higher interest rate greatly increases the return that retirees and pensioners receive on both these sources of savings.</p>
<p>Rate rises haven’t received nearly as much press as the increase in mortgage rates, but interest rates for savings accounts have also risen over the past year.</p>
<h2>Higher interest rates are great for travellers</h2>
<p>Whenever the Reserve Bank increases the cash rate, the dollar is directly affected. A higher interest rate means a <a href="https://www.rba.gov.au/publications/rdp/2019/2019-07.html">stronger Australian dollar</a>. This is a boon to anybody who wants to travel overseas.</p>
<p>The stronger Australian dollar means that whether you are buying a pint of beer in London or a piña colada in Puerto Rico, it will be cheaper for you to spend your money overseas, and your holidays will be more affordable as a result.</p>
<p>The combination of a strong Australian dollar and a weak pound means there has never been a better time to visit the United Kingdom and enjoy some warm beer and mushy peas!</p>
<h2>High interest rates are great for anyone who drives</h2>
<p>Just as a stronger Australian dollar makes overseas travel cheaper, it also keeps the price of imports down. And Australia imports a lot of important goods.</p>
<p>Our biggest single import is cars. Australia imports all its cars, ever since the demise of the local car manufacturing industry. The second biggest import is refined petroleum. Given that cars, and the fuel that runs them, is a non-discretionary good for most households, keeping their price low is important for most consumers.</p>
<p>Higher interest rates help do exactly that, keeping our dollar strong and the price of new cars and petrol down.</p>
<h2>But what about my mortgage?</h2>
<p>This is not to say that the conventional wisdom - that higher rates are a net negative for the modal household - is wrong. Obviously anyone who is paying off a mortgage debt of hundreds of thousands of dollars is going to be financially disadvantaged by higher interest rates.</p>
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Read more:
<a href="https://theconversation.com/high-interest-rates-are-not-bad-news-for-everyone-just-ask-savers-importers-and-australians-heading-overseas-210466">High interest rates are not bad news for everyone. Just ask savers, importers and Australians heading overseas</a>
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<p>But it’s important to keep in mind that not all Australian households are net-borrowers, and that there is nothing inherently evil about higher interest rates.</p>
<p>There are many reasons why a higher interest rate is a good outcome, far better than a world in which rates are trapped at 0 per cent forever. High interest rates may not be here forever. We should enjoy them while we can.</p><img src="https://counter.theconversation.com/content/210466/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Isaac Gross does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>We hear a lot about the negative impact of rate rises on mortgage repayments while little is made of the benefits of high interest rates.Isaac Gross, Lecturer in Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2110682023-08-21T13:47:46Z2023-08-21T13:47:46ZHow rising interest rates are affecting UK businesses<figure><img src="https://images.theconversation.com/files/543717/original/file-20230821-23-2hink2.jpg?ixlib=rb-1.1.0&rect=0%2C33%2C7326%2C4858&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/worried-business-owner-working-his-shop-2199248649">Stock-Asso/Shutterstock</a></span></figcaption></figure><p>From <a href="https://www.theguardian.com/business/2023/aug/03/were-just-treading-water-uk-small-business-owner-higher-interest-rate-taking-their-toll?utm_term=64ccabd424ac776f6436d425fc8da30c&utm_campaign=BusinessToday&utm_source=esp&utm_medium=Email&CMP=bustoday_email">chip shops</a> to <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">tech start-ups</a>, and even large, <a href="https://www.standard.co.uk/news/uk/wilko-administration-high-street-retail-interest-rates-b1098476.html">well-established companies</a>, rising interest rates have had an impact right across the business world. After <a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">14 consecutive base rate hikes by the Bank of England</a> since 2021, this is causing particular problems for companies with a lot of debt. </p>
<p>We recently saw the chaos this can cause when English utility <a href="https://www.bbc.co.uk/news/business-66051555">Thames Water</a> nearly collapsed under the weight of its debt and had to seek emergency funding from its shareholders earlier this year. </p>
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<a href="https://theconversation.com/how-thames-water-came-to-be-flooded-with-debt-and-what-it-means-for-taxpayers-208788">How Thames Water came to be flooded with debt – and what it means for taxpayers</a>
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<p>More recently, budget retailer Wilko’s borrowing not only affected the business and its shareholders, but also its employees when its recent collapse put <a href="https://www.wionews.com/business-economy/uk-retailer-wilko-collapses-due-to-big-debts-12500-jobs-at-risk-624323">12,500 jobs at risk</a>.</p>
<p>Similar problems could arise among many other companies and industries. Financial markets expect the bank base rate – which dictates the rates on many types of loans – will keep climbing: it’s currently <a href="https://www.thetimes.co.uk/money-mentor/article/when-will-interest-rates-go-down-uk/">forecast to peak</a> between 5.75% and 6% by the start of 2024. And the <a href="https://www.statista.com/statistics/793368/value-of-business-corporate-loans-united-kingdom/">total value of UK business loans</a> is also expected to rise to an estimated £513 billion as of 2023. This is £78 billion higher than in 2018, an increase of 18%.</p>
<p>Company insolvencies have <a href="https://www.reuters.com/world/uk/england-wales-report-40-rise-company-insolvencies-2023-06-16/">already jumped by 40%</a> over the year to May 2023 in England and Wales – the highest level since monthly records began in January 2019. And significant debt problems within an industry or even one firm can cause a domino effect across the UK economy. </p>
<p>Research shows the effects of an insolvency or bankruptcy <a href="https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/spreading-the-misery-sources-of-bankruptcy-spillover-in-the-supply-chain/B87035D235D7AA2A443B5164C28EBA5B">can spread</a> to a firm’s trading partners. Wilko started to defer supplier payments and extend the timeframe in which it settles invoices <a href="https://www.retailgazette.co.uk/blog/2022/09/wilko-delays-supplier-payments/">last year</a> to try to ease pressure on its cash flow as it struggled to manage its debts.</p>
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Read more:
<a href="https://theconversation.com/wilko-is-the-latest-shop-to-be-edged-out-by-competition-but-it-doesnt-have-to-mean-the-end-for-the-budget-retailer-211161">Wilko is the latest shop to be edged out by competition but it doesn't have to mean the end for the budget retailer</a>
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<p>So, with interest rates likely to continue to rise, being able to tell if another company or industry is at risk is important for customers, employees, investors and other connected businesses such as suppliers.</p>
<h2>The rising cost of business borrowing</h2>
<p>The average cost of new borrowing from banks by private non-financial companies was <a href="https://www.bankofengland.co.uk/statistics/money-and-credit/2023/june-2023">6.36% in June 2023</a>, more than 4 percentage points above the December 2021 rate of 2.03% (when the Bank of England base rate increases began). For small and medium-sized enterprise (SMEs), new loan rates increased from 6.86% in May to a record high of 7.13% in June (compared with 2.51% in December 2021). </p>
<p>Companies already holding debt that’s not on a fixed rate of interest could also see an increase in the interest owed to their lender. This could come as a shock since UK interest rates were <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">1% or less</a> for more than 13 years from February 2009 to June 2022. During this time, the pressure of debt on borrowers was light or negligible.</p>
<p><strong>The base rate has recently climbed from low levels</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the Bank of England base rate rising from less than 1% in 2020 to 5.25% by August 2023. by" src="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=345&fit=crop&dpr=1 600w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=345&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=345&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=433&fit=crop&dpr=1 754w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=433&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=433&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The Bank of England base rate from January 2020 to August 2023.</span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates">The Bank of England</a></span>
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<p>Companies that got used to being able to borrow at a low cost are now starting to feel the pinch, or even come under extreme pressure if they are heavily indebted. This is what worsened the <a href="https://news.sky.com/story/thames-water-secures-additional-750m-from-shareholders-in-race-to-avoid-nationalisation-12918285">financial position of UK utility Thames Water</a>. When the company was privatised in 1989, it had no debt. But over the years it borrowed heavily to fund new investments. </p>
<p>Generally speaking, debt is a <a href="https://www.ofwat.gov.uk/thames-debt-and-water-sector-finance/">prudent low-cost source of finance</a> with low interest rates fixed for the long term. But Thames Water borrowed too much. It had <a href="https://www.bbc.co.uk/news/business-66051555">£14 billion in debt by the end of June 2023</a>, which amounted to 80% of the value of the business and made it the most heavily indebted of England and Wales’ water companies, according to analysts. Its loan repayments were not only linked to the bank base rate, but also inflation, which has also spiked over the past year. This triggered fears about the company’s ability to continue to service its debts.</p>
<p>Thames Water was lucky, in a sense – it avoided being nationalised because it was able to secure timely funding from its shareholders. But the situation revealed the extent of the iceberg under the water in this industry. Shortly afterwards, another English utility, Southern Water, announced <a href="https://www.reuters.com/world/uk/britains-southern-water-suspends-dividend-amid-growing-debt-pile-rating-2023-07-07/">it would not pay dividends</a> until at least 2025 after its credit rating was downgraded. This shows investors, lenders and credit ratings agencies are getting more nervous about debt-related trends within industries.</p>
<p>Businesses can help to ease such concerns by being transparent.
<a href="https://onlinelibrary.wiley.com/doi/full/10.1002/bse.3055">Research</a> shows that the more firms disclose financial and non-financial information, the more likely they are to be able to secure loans and access lower rates. This also applies to companies that are <a href="https://www.sciencedirect.com/science/article/abs/pii/S0167268117302263">more open with external partners</a> by sharing resources and knowledge to enhance innovation. The more information a bank has, the more comfortable it will be about lending to a company. It also reduces the bank’s own risk rating, allowing it to lend more and offer lower rates. </p>
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<img alt="Man in suit with blue tie holding three blocks showing bank symbol, rating symbol and chart symbol with arrow and percentage, with " src="https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Credit ratings influence how much and to which companies banks will lend.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/credit-rating-concept-finance-banking-investment-2248616763">Panchenko Vladimir/Shutterstock</a></span>
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<h2>What to look out for in the current environment</h2>
<p>Business leaders that are addressing rising interest rates head-on may announce adjustments to their growth or expansion plans, especially if a plan previously relied heavily on debt. They may also consider different sources of finance. The UK water regulator, for example, has called on utilities to consider the role of equity funding (<a href="https://www.british-business-bank.co.uk/finance-hub/what-is-equity-finance/">for example, selling shares</a>) and <a href="https://www.ofwat.gov.uk/thames-debt-and-water-sector-finance/">not just debt</a> in financing new investment.</p>
<p>A company’s <a href="https://www.investopedia.com/terms/d/debtratio.asp#:%7E:text=The%20debt%20ratio%20is%20defined,that%20are%20financed%20by%20debt.">ratio of debt versus assets</a> will also tell you how much it holds in debt. A “good” debt ratio is around 1 to 1.5, but <a href="https://www.british-business-bank.co.uk/finance-hub/what-level-of-debt-is-healthy-for-business/">the ideal can vary</a> by industry. Manufacturers, for example, tend to need a lot of equipment and so may have ratios greater than 2.</p>
<p>More interest rate rises will pile pressure on companies, employees and the economy. But by anticipating the impact on their debt and being more open about their current state and future plans, businesses can help to minimise the pain.</p><img src="https://counter.theconversation.com/content/211068/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Erwei (David) Xiang does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Recent interest rate hikes are not just a problem for mortgage borrowers, many companies are suffering too.Erwei (David) Xiang, Senior Lecturer (Associate Professor) in Accounting, Newcastle UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2106182023-08-17T01:36:45Z2023-08-17T01:36:45ZJapan has gone its own way on fighting inflation – can NZ learn from a global outlier?<p>Like most countries over the past three years, New Zealand has tried to manage inflation by increasing interest rates. Japan, on the other hand, has taken a different tack – with clear success.</p>
<p>In 2016, the Bank of Japan (BoJ) <a href="https://tradingeconomics.com/japan/interest-rate">set the country’s interest rate at -0.1%</a> and left it there. During the same period, the Reserve Bank of New Zealand (RBNZ) has adjusted the interest rate <a href="https://tradingeconomics.com/new-zealand/interest-rate">18 times</a>, with 12 upward adjustments since the end of 2021. </p>
<p>Japan’s annual inflation rate <a href="https://www.rateinflation.com/inflation-rate/japan-inflation-rate/">peaked at 4.4%</a> in January 2023, while New Zealand’s <a href="https://www.rateinflation.com/inflation-rate/new-zealand-inflation-rate/">peaked at 7.3%</a> in June 2022, before dropping to 6.0% in June this year. </p>
<p>What might explain these differences in interest rate policy and inflation outcomes? The answer begins with how Japan views inflation in the first place. </p>
<h2>Inflation as a supply issue</h2>
<p>Since the early 1980s, most central banks have believed inflation could be combated by increasing the base interest rate. This would cause domestic demand for goods and services to decrease, suppress wages and increase unemployment – eventually triggering a fall in general price levels. </p>
<p>New Zealand enshrined this approach in the Reserve Bank Act 1989, which introduced the <a href="https://teara.govt.nz/mi/reserve-bank/print">RBNZ monetary framework</a>. Since 1999, the main policy tool for adjusting inflation has been the official cash rate (OCR), more or less mirroring the global central bank consensus.</p>
<p>Put bluntly, raising the OCR suppresses demand until unemployment is high enough for prices to fall. </p>
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Read more:
<a href="https://theconversation.com/uk-interest-rates-crashing-the-economy-is-no-way-to-bring-down-inflation-211050">UK interest rates: crashing the economy is no way to bring down inflation</a>
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<p>In contrast to New Zealand and elsewhere, <a href="http://www.boj.or.jp/en/mopo/mpmsche_minu/minu_2023/g230428.pdf">the BoJ board</a> sees the recent inflation episode as primarily caused by “transient” supply issues. So, raising interest rates to suppress demand has no effect on supply chains disrupted by things such as a global pandemic, the war in Ukraine or cuts to oil production. </p>
<p>While not necessarily short lived, these disruptions are seen by Japan’s central bank as transient because they are unlikely to cause permanent structural changes. With it’s focus on supply issues, Japan has ultimately fared better. </p>
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<h2>Why interest rates could be inflationary</h2>
<p>There are three reasons why Japan’s refusal to tinker with interest rates may have been more successful at fighting inflation than New Zealand’s orthodox policy of raising rates.</p>
<p><strong>1. Interest income</strong></p>
<p>Securities such as <a href="https://sorted.org.nz/guides/saving-and-investing/bonds">government bonds</a> attract interest. So, raising interest rates has meant new interest income began flowing from the public to private sector – in particular to those who have the money to invest in government bonds. </p>
<p>Treasury has calculated that <a href="https://www.treasury.govt.nz/publications/efu/budget-economic-and-fiscal-update-2023">interest income will more than double</a> in 2023 – meaning an extra NZ$3.4 billion will flow to private sector investors. At least some of those billions will be spent on goods and services, adding to New Zealand’s <a href="https://www.rnz.co.nz/news/business/465124/consumer-spending-trend-concerning-amid-high-inflation">existing inflationary pressures</a>. </p>
<p>Japan’s policy of holding the interest rate below 0% means issuing government securities does not provide significant new interest income, which would ultimately put upward pressure on prices.</p>
<p><strong>2. Employment</strong></p>
<p>Employment – and unemployment – are viewed differently in Japan, where the unemployment rate is 2.7% and hasn’t been <a href="https://www.stat.go.jp/english/data/roudou/results/month/index.html#TAB">above 3% since 2017</a>. </p>
<p>The <a href="https://www.nzherald.co.nz/business/adrian-orr-beating-inflation-will-mean-higher-unemployment/WO3WLQQUGWEC5NVK3AQTR2BN5A/">RBNZ</a>, by comparison, forecasts rising interest rates will lead to rising unemployment, possibly tipping above 5% in the near future.</p>
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<a href="https://theconversation.com/interest-rates-the-case-for-cutting-them-permanently-to-zero-209427">Interest rates: the case for cutting them permanently to zero</a>
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<p>Japan’s workers benefit from an “<a href="https://www.imf.org/en/Publications/fandd/issues/2023/03/POV-time-for-change-masaaki-shirakawa">implicit contract</a>” between business and the rest of Japanese society, which delivers long-term employment. This implicit contract drives the BoJ policy of keeping interest rates low to fight inflation. </p>
<p>This policy broadly aligns with what’s known as “<a href="https://www.imf.org/en/Publications/WP/Issues/2016/12/31/Okun-s-Law-Fit-at-50-40236">Okun’s Law</a>”. This links increasing unemployment with a reduction in productive output. New Zealand’s policy of increasing unemployment by raising interest rates therefore restricts production, putting upward pressure on prices by restricting supply.</p>
<p>Adding to this, increased welfare payments due to rising unemployment maintain demand for consumer goods at the same time as output is restricted. <a href="https://www.treasury.govt.nz/publications/efu/budget-economic-and-fiscal-update-2023">The New Zealand Treasury</a> forecasts welfare payments will increase by $10 billion over the next four years.</p>
<p>The BoJ policy of keeping the interest rate below zero supports productive output and suppresses the need for increased welfare payments. This likely keeps prices down, as reflected in Japan’s better inflation targeting performance. </p>
<p>The RBNZ policy of increasing rates, on the other hand, restricts output and increases welfare payments, likely adding to inflationary pressures.</p>
<p><strong>3. Business expenses</strong></p>
<p>Finally, raising interest rates might be inflationary when businesses require credit to operate. Compared to Japan, New Zealand businesses now have comparatively higher interest costs. </p>
<p>Increased interest costs translate into increased operational costs that can be passed through to consumers in the form of higher prices. </p>
<p>Increased interest costs in New Zealand are therefore more likely to be inflationary than Japan’s below-zero policy rate. This is reflected in recent inflation data from the two economies. </p>
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<h2>Reexamining inflation orthodoxy</h2>
<p>The Bank of Japan’s divergence from monetary policy orthodoxy raises an important question: by raising interest rates to combat inflation over nearly four decades, have central banks been stamping on the inflation accelerator rather than the brakes? </p>
<p>Furthermore, did hundreds of thousands of New Zealanders need to lose their jobs at various times during this period?</p>
<p>By deliberately leaving the interest rate below zero, Japan has seen better inflation outcomes than New Zealand, where official policy has seen rates continually adjusted – the majority of which were increases. </p>
<p>There are other factors that <a href="https://www.weforum.org/agenda/2022/10/why-japan-low-inflation/">may contribute</a> to Japan’s low inflation, such as government price controls and an ageing population. But as New Zealand tries to manage rising costs of living, it may be time to examine Japan’s approach and question orthodox wisdom about dealing with inflation.</p><img src="https://counter.theconversation.com/content/210618/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael Mouat does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>With an inflation rate peaking at just 4.4%, Japan seems to be getting something right about managing economic pressures. How does it do this, and should New Zealand revisit its own strategies?Michael Mouat, Researcher in Economic Geography, Massey UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2094272023-08-09T14:31:04Z2023-08-09T14:31:04ZInterest rates: the case for cutting them permanently to zero<figure><img src="https://images.theconversation.com/files/541544/original/file-20230807-27-xsmepo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>In 1937 the English economist Joan Robinson <a href="https://archive.org/details/dli.ernet.13867/page/n265/mode/2up?view=theater">proposed that</a> “when capitalism is rightly understood, the rate of interest will be set at zero and the major evils of capitalism will disappear”. <a href="https://www.britannica.com/biography/John-Maynard-Keynes">John Maynard Keynes</a>, who had taught Robinson, <a href="https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch16.htm">suggested something</a> similar a year earlier in slightly more qualified and technical terms, arguing that this would be “the most sensible way of gradually getting rid of many of the objectionable features of capitalism”.</p>
<p>Robinson and Keynes were writing during the great depression, when spending and investment were moribund and interest rates seemed like a stranglehold on the economy. Unlike the sort of <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate#:%7E:text=21%20September%202023-,Official%20Bank%20Rate,-Official%20Bank%20Rate">temporary measure</a> we saw from 2009-21 when rates were close to zero, they believed interest rates should be set at zero permanently as a way to purge capitalism of its most objectionable and destabilising features. </p>
<p>This was a time when the Soviet Union was challenging the western model of prosperity. Indeed, Robinson’s argument was in response to a Marxist, proposing it would lead to “even better results than the revolutionist theory”. </p>
<p>With interest rates rising steeply in the past couple of years and capitalism <a href="https://iea.org.uk/publications/left-turn-aheadsurveying-attitudes-of-young-people-towards-capitalism-and-socialism/">deeply unpopular</a> among younger generations, it is worth returning to this idea. So what was the logic and how would it work?</p>
<h2>The rationale</h2>
<p>Inflation is sustained by consumers, businesses and governments spending in excess of the supply of goods and services. Central banks raise interest rates to reduce demand by discouraging borrowing and spending. This aims to restore equilibrium between supply and demand, and reduces inflationary pressure. </p>
<p>A major problem – setting aside the question of how well it works – is that this distributes the cost of curbing inflation very unevenly. A <a href="https://www.ft.com/content/02f151aa-40a0-4d07-8335-61d02aa6dc4e">recent report</a> by the Royal Bank of Canada said higher interest rates disproportionately hurt poorer and younger people, such as renters and first-time homebuyers. <a href="https://moneyzine.com/uk/resources/debt-statistics-uk/">Anyone borrowing</a> out of financial distress is likely to be in trouble with rising rates. </p>
<p>There are additional objections to positive interest rates. One relates to depleting resources. </p>
<p>Suppose I own a forest that regenerates at 2% per year and is worth £1 million in timber overall. I could log the forest sustainably, cutting down trees only in line with the speed of regeneration, which would earn me £20,000 a year. </p>
<p>But with interest rates at 5.25%, I would do better to cut down everything, invest my £1 million into bonds, and earn upwards of £52,500 in annual interest (I say upwards because the rate of interest on bonds is usually a little way above the central bank base rate). </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Aerial view of a forest" src="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=449&fit=crop&dpr=1 600w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=449&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=449&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=565&fit=crop&dpr=1 754w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=565&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/541469/original/file-20230807-21-zpbybv.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=565&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Wooden thinking.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/aerial-top-view-summer-green-trees-1024452661">nblx</a></span>
</figcaption>
</figure>
<p>If the interest rate were zero, it would reduce my incentive to log the entire forest today. It’s true I could still cut it all down and earn a passive income in other ways, such as holding shares that pay good dividends. But that would involve slightly more risk, since dividends are not guaranteed, and the underlying shares might lose value. </p>
<p>In general, to quote a <a href="https://www.theguardian.com/commentisfree/2023/may/06/central-banks-interest-rate-hike-climate-crisis">recent op-ed</a>, central banks raising interest rates make it harder to fight the climate crisis. A permanent zero rate might also discourage wealthy people from parking their money in bonds to earn a passive guaranteed income rather than taking entrepreneurial risks. </p>
<h2>The fiscal alternative</h2>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="JK Galbraith looking pensive" src="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=798&fit=crop&dpr=1 600w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=798&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=798&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1003&fit=crop&dpr=1 754w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1003&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/541470/original/file-20230807-26-d7b2lo.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1003&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">JK Galbraith.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/John_Kenneth_Galbraith#/media/File:JK_Galbraith_1962.jpg">Wikimedia</a></span>
</figcaption>
</figure>
<p>If the interest rate were permanently zero, the government’s fiscal levers of taxation and spending would be the alternative means of controlling inflation. The economist John Kenneth Galbraith <a href="https://archive.org/details/economicspublicp0000galb">made the point</a> that using progressive taxes rather than interest rates to control spending would put the greatest costs of maintaining stable prices on those best placed to weather them.</p>
<p>Targeted consumption taxes, for instance on luxury goods or products with an needlessly high carbon footprint, could be used to ensure that the most socially undesirable forms of spending are the first to be reduced during inflation. Likewise, socially desirable forms of spending such as essential infrastructure would be the first to increase during recessions. </p>
<p>Such a system would require several other changes. There would always be a danger that the government would manipulate tax and spending to try and win an election rather than focusing on inflation. This was the main reason independent central banks were given control over interest rates in the first place. </p>
<p>We could prevent that by restricting the inflation-controlling levers to just a few types of tax and spending. We could then give an independent body oversight of these levers to make sure they were not exploited for electoral purposes.</p>
<p>At the same time, there is a risk that permanent zero rates might encourage commercial banks to lend more irresponsibly. There wasn’t a lot of evidence of this <a href="https://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=GB">in the UK</a> when rates were close to zero in the 2010s. But we did see other economically hazardous activities such as companies borrowing cheaply to buy back their shares to drive up their prices. New regulatory frameworks could be introduced to prevent these kinds of activities. </p>
<p>Giving up control of the interest rate needn’t remove all central-bank control over lending. The “<a href="http://nyborg.ch/book/">open secret of central banks</a>” is that they also control lending through a <a href="https://www.bankofengland.co.uk/markets/eligible-collateral">list of types of loans</a> that they are willing to take as collateral in exchange for providing banks with reserves (in practice these transactions are often indefinitely renewable, so they’re more like purchases).</p>
<p>Banks are strongly motivated to lend to customers according to this framework, since it gives them access to liquidity at low cost. Central banks claim to maintain “neutrality” on the types of loans on these lists, though <a href="https://www.cepweb.org/central-bank-market-neutrality-is-a-myth/">others would disagree</a>. The <a href="https://www.bankofengland.co.uk/-/media/boe/files/markets/eligible-collateral/summary-table-of-collateral.pdf">Bank of England includes</a> mortgages but not construction loans, for instance, encouraging banks to lend more for buying houses than building them. Instead, central banks could openly use these frameworks to <a href="https://www.bloomberg.com/news/articles/2020-10-14/lagarde-says-ecb-needs-to-question-market-neutrality-on-climate">guide banks</a> into making low-risk loans for socially and environmentally responsible ventures. </p>
<h2>The future of central banks</h2>
<p>Also <a href="https://www.bankofengland.co.uk/explainers/what-is-a-central-bank-digital-currency">worth mentioning</a> is the current push by the Bank of England towards <a href="https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-central-bank-digital-currency-cbdc">central bank digital currencies</a> (CBDCs), in which buyers and sellers would transfer money directly without having to use the banking system. This could enable central banks to encourage or discourage certain spending in more targeted ways, for example by restricting what can be spent by people in certain areas or income brackets. If inflation was controlled using only fiscal levers, CBDCs could be used to reinforce this policy. </p>
<p>The idea of permanent zero rates is far outside the mainstream of economic thinking. But perhaps Robinson was right to suggest it as a viable compromise between capitalism and more radical alternatives: rewarding entrepreneurship without compounding inequality or incentivising the unsustainable use of resources. At a time like this, it’s an old idea well worth considering.</p><img src="https://counter.theconversation.com/content/209427/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Douglas receives funding from the Arts and Humanities Research Council for the Future of Work and Income Research Network (fwirn.co.uk).</span></em></p>Why it’s time to reconsider an idea that was popular with economists during the great depression.Alexander Douglas, Lecturer in Philosophy, University of St AndrewsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2110502023-08-04T14:19:20Z2023-08-04T14:19:20ZUK interest rates: crashing the economy is no way to bring down inflation<figure><img src="https://images.theconversation.com/files/541238/original/file-20230804-495-ugyy8l.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">It won't hurt a bit. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-illustration-creative-red-car-crash-2322994587">Kevin CC</a></span></figcaption></figure><p>The Bank of England (BoE) has <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/august-2023">raised</a> interest rates once again to 5.25%, mirroring similar moves by the <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230726a.htm">Federal Reserve</a> and the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230727%7Eda80cfcf24.en.html">European Central Bank</a>. The fact that the UK is still suffering from <a href="https://www.cnbc.com/2023/07/19/uk-inflation-rate-slides-to-7point9percent-in-june-below-expectations.html">high inflation</a> – higher than either <a href="https://www.bbc.co.uk/news/business-66178936">the US</a> or <a href="https://www.thetimes.co.uk/article/eurozone-surprises-with-faster-growth-as-inflation-hits-new-low-kzj7wtgj0">eurozone</a> – made another rate rise appear inevitable.</p>
<p>Yet there are reasons to doubt the merits and effectiveness of this approach. The UK’s efforts to bring down inflation quickly could be risking the health of the economy. </p>
<p>It is important to understand how monetary policy “works”. In effect, the BoE is seeking to make <a href="https://www.bbc.com/news/business-65308769">households</a> in particular poorer so they spend less. The idea is you dampen down demand to bring it into line with supply, so that upward pressure on prices can be curbed. </p>
<p>The other effect of raising rates is to reduce the wage demands of workers by <a href="https://www.theguardian.com/business/grogonomics/2023/feb/09/the-reserve-bank-wants-unemployment-to-rise-it-should-be-careful-what-it-wishes-for">creating unemployment</a>. This is not the publicly stated goal, but it lies behind the rhetoric of wage restraint that the BoE <a href="https://www.ft.com/content/4973fd9c-641f-4df2-87c3-bff77eb2406f">continually espouses</a> – despite nominal wage growth <a href="https://www.hrmagazine.co.uk/content/news/real-wages-rise-for-first-time-in-18-months/">only recently</a> matching inflation.</p>
<p>The current approach to monetary policy accepts a recession as a price worth paying, while implying a belief that higher unemployment leads to lower inflation. This can be disputed on economic grounds - in the UK in the recent past, low inflation was achieved with low unemployment, so the idea that there is a necessary trade-off between inflation and unemployment can be refuted historically. </p>
<p>There are also moral objections to current monetary policy. It can be argued that the BoE should have a responsibility to protect living standards, not harm them. Its mandate of achieving a 2% inflation target should not be at any cost. Creating unemployment will impose misery on many workers and have scarring effects on the economy, from lost skills to reduced industrial capacity, which may be difficult to heal.</p>
<h2>The economic reality</h2>
<p>The current inflation is also not a classic case of “too much money chasing too few goods”. There are pressures from higher <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/foodandenergypriceinflationuk/2023">food and energy prices</a> linked to factors like Brexit and the Ukraine war that cannot be controlled by raising interest rates. </p>
<p>There are also structural problems in the UK, such as labour shortages due to increases in economic inactivity – the result of more over-50s leaving the workforce and rises in ill health. These problems are seen to have put <a href="https://publications.parliament.uk/pa/ld5803/ldselect/ldeconaf/115/11504.htm">upward pressure on wages</a>, and require responses beyond raising interest rates if they are to be fully addressed. </p>
<p>For example, they require new investment in the health sector to help alleviate hospital waiting lists. A better-funded NHS would create a healthier workforce, overcoming current limits on labour supply due to poor health that are seen to be creating inflationary pressures. </p>
<p>In any case, inflation is set to come down – the BoE’s <a href="https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2023/august/mpr-august-2023-opening-remarks-slides.pdf">own forecasts</a> show this. Monetary tightening at this stage is therefore short-sighted and probably counterproductive – especially when the BoE thinks deflation is distinctly possible in the next couple of years. A more cautious approach to monetary policy seems in order.</p>
<p>Other countries have followed different policies with different effects. <a href="https://www.theguardian.com/commentisfree/2023/aug/03/spain-inflation-lower-bank-england-interest-rates">Spain</a>, for instance, has used mechanisms such as price controls on things like rents and energy to help curb inflation (the UK did also cap energy bills, though not as aggressively). This has helped to reduce inflation while keeping employment high. It shows that crashing the economy is not the only route to low inflation.</p>
<p>In short, the BoE is simply compounding problems rather than solving them through its actions. It is time it learnt the limits of its own policies, while the government needs to play a role too. </p>
<p>In the short term, attention should be given to controlling prices (including energy) and making businesses show restraint in their pricing behaviour. Longer term, greater investment in skills, health and productive capacity is needed to create an economy that allows for rising real living standards with full employment.</p><img src="https://counter.theconversation.com/content/211050/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Spencer receives funding from the ESRC</span></em></p><p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Bank of England has just raised rates for the 14th time in a row to 5.25%.David Spencer, Professor of Economics and Political Economy, University of LeedsMuhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2088532023-08-04T11:59:41Z2023-08-04T11:59:41ZFive ways to take advantage of rising interest rates to boost your savings<figure><img src="https://images.theconversation.com/files/539289/original/file-20230725-12812-rqkfwb.jpg?ixlib=rb-1.1.0&rect=186%2C28%2C6043%2C4072&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">It's always a good time to save more, if you can.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/smiling-black-woman-saving-goal-future-2253367631">tommaso79/Shutterstock</a></span></figcaption></figure><p>With the Bank of England base rate <a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">currently the highest</a> it has been since early 2008, you may have a valuable opportunity to increase your earnings on pensions, investments and savings accounts. After all, when the central bank raises its main rate – the base rate, which is typically used as a benchmark for loans as well as savings accounts – it is trying to encourage people to spend less and save more.</p>
<p>But UK banks and building societies have <a href="https://www.independent.co.uk/money/martin-lewis-savings-rates-mortgage-crisis-b2362955.html">recently been accused</a> of letting their savings rates lag the recent rapid rise in the base rate. UK regulator the Financial Conduct Authority has urged these financial firms to offer “<a href="https://www.fca.org.uk/news/press-releases/action-plan-cash-savings">fair and competitive</a>” savings rates in response to the increasing interest rates. </p>
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Read more:
<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">Interest rates: why your mortgage payments are going up but your savings aren't – and how better monetary policy could help</a>
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<p>Many financial institutions do offer accounts with <a href="https://www.theguardian.com/money/2023/jul/15/uk-savings-accounts-interest-nsi-building-societies-banks-deals">rates of 6% or more</a>. This is good news for avid savers – but only if you keep an eye on the market so you can switch from less competitive products. This is why it’s important to establish a regular savings habit, but many people are unsure about what that should involve.</p>
<p>My colleagues and I have studied the <a href="https://dspace.stir.ac.uk/handle/1893/32240">correlation between people’s savings goals</a> (if they have any) and how they invest their money. We also looked at how seeking financial information advice, and being “good with numbers”, both influence this correlation. </p>
<p>We analysed data from more than 40,000 individuals in 21,000 UK households from five waves of the Office for National Statistics Wealth and Assets Survey (WAS), conducted between 2006 and 2016. This data captures comprehensive economic wellbeing information and attitudes to financial planning. </p>
<p>Our research shows the importance to your finances of setting multiple savings goals, keeping up with financial news, and seeking professional advice. Based on this, here are five research-based ways to make the most of your money.</p>
<h2>1. Set specific savings goals</h2>
<p>Establishing personal savings goals is one of the first steps most financial institutions and advisers will recommend to their customers, because it’s a good idea to <a href="https://www.investopedia.com/terms/c/compoundinterest.asp">save regularly</a>. Plus, our study shows that total financial assets increase in line with the number of savings goals you have, and that setting specific, rather than vague, goals leads to higher performance.</p>
<p>Specific savings goals should have an end date, target figure, and even a meaningful name – for example, “£1,000 for 2024 trip to Asia” or “£250 for 2023 Christmas present fund”. This will create tangible reference points that encourage self-control and increase the pain you feel if you fail to meet your goal.</p>
<figure class="align-center ">
<img alt="Three glass jars of coins with labels that say: insurance, retirement, travel plan." src="https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=338&fit=crop&dpr=1 600w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=338&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=338&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=425&fit=crop&dpr=1 754w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=425&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=425&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Savings goals – but try an interest-bearing account, rather than a jar.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/money-coins-jars-insurance-savings-retirement-1036970458">simon jhuan/Shutterstock</a></span>
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</figure>
<h2>2. Seek professional financial advice</h2>
<p>Rather than relying on friends, family and social media for financial advice, speak to an expert.</p>
<p>Our research shows households that access professional financial advice were more likely to allocate a higher share of their wealth to stock portfolios than those that rely on friends, family and social media for financial advice. This result was consistent even across different wealth and income levels, with lower earners possibly using products like ISAs to make investments in stocks and shares. Other <a href="https://academic.oup.com/qje/article/134/3/1225/5435538">research shows</a> stock portfolios outperform most other types of investment in the long term.</p>
<p>We also found that access to professional financial advice can substitute for setting goals, because your adviser should help you to determine the kinds of products to invest in (which is called asset allocation) for specific timelines and aims.</p>
<h2>3. Brush up on your maths</h2>
<p><a href="https://doi.org/10.1111/j.1475-5890.2007.00052.x">Several studies</a> show numerical skills affect how households gather and process information, <a href="https://psycnet.apa.org/doi/10.1037/a0013114">set goals</a>, perceive risks, and <a href="https://heinonline.org/HOL/P?h=hein.journals/fedred89&i=791">decide to invest</a> in various financial assets. So, by brushing up on your basic numeracy and financial literacy skills – even with free online videos – you could boost your savings for the long term. </p>
<p>Our study shows that individuals with high confidence in their numerical skills tend to have better financial planning habits – such as investing more in stocks and bonds than cash, which carries more risk but also the potential for greater returns. This trend is particularly evident among households with no savings goals, suggesting that numerical ability could compensate for failing to set such goals.</p>
<figure class="align-center ">
<img alt="Overhead shot of person at desk with papers, pen & notebook, watching video on laptop of woman at a whiteboard." src="https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Brush up on your maths skills.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/high-angle-view-video-conference-teacher-1676998303">Ground Picture/Shutterstock</a></span>
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<h2>4. Adopt appropriate savings strategies</h2>
<p>Diversified stock market portfolios generally outperform bonds and cash savings <a href="https://doi.org/10.1093/qje/qjz012">over longer periods</a>. However, stock markets can be volatile, so putting savings into less risky assets like bonds and cash is wise for savings goals of less than five years.</p>
<p>In the longer term, investing across different global stock markets for more than five years can help counteract inflation. And you can access low-cost, diversified investment portfolios via financial products based on indices of stocks or other assets, such as exchange traded funds.</p>
<h2>5. Set, monitor and adjust your plan</h2>
<p>Free financial planning and budgeting apps can help you save money by tracking your spending and savings goals, and encouraging you to adhere to a budget.</p>
<p>Most importantly, once you set savings goals and create a budget, don’t forget about them. Check regularly to see how your savings are building up and to monitor for any spending changes. A growing array of fintech tools can prompt and encourage this kind of long-term planning.</p>
<p>Keeping an eye on savings rates is also important. As banks change rates or create new accounts, consider switching to get a better deal if you can do so without falling foul of account closure fees.</p>
<p>It’s important to make sure your savings are working for you at any time, but its crucial in the current economy, when finances are tight but interest rates are rising.</p><img src="https://counter.theconversation.com/content/208853/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Fredrick Kibon Changwony does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Specific savings goals can help increase your pot – but so can advice and confidence with numbers.Fredrick Kibon Changwony, Lecturer in Accounting & Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.