Will it remain in the history books as the blessed era when nations, families, and corporations were able to get into near-free debt, while at the same time benefiting from increasing their assets? Or is the expiring decade to blame for the global economy being pushed into recession? Anyway, one day the party had to end.
It was the eventual return of inflation, which we thought had disappeared for good under the influence of globalization and productivity gains, that succeeded in overcoming this unprecedented situation of zero or even negative interest rates. Central banks are forced to correct the situation, having propped up the global economies drained by the financial crisis by massively pumping money and lowering prices.
The European Central Bank (ECB) is preparing to start the process of normalizing its monetary policy on Thursday, June 9, which should lead to an increase in its key interest rate during the summer. An inevitable return to normal, which, however, calls into question the ability of the planet’s great fundraisers to carry out this weaning without much harm. explanations.
► Why are prices rising?
The primary task of central banks is to ensure price stability, by raising or lowering interest rates with the aim of reviving or slowing growth. However, having struggled for years against the risks of deflation, central banks had to face, at the end of the health crisis, an unexpected return to inflation. At first, they were temporary, considering that the price hike, associated with the warming of the economy, would be only temporary. But with inflation becoming more persistent, driven especially in the US by rising consumption, central banks have finally responded.
In January, the US central bank was the first to use the weapon of interest rates, and announced its first hike in March 2022. For its part, the European Central Bank waited for the outbreak of the war in Ukraine, and its consequences for rising energy and food prices. to intervene. Faced with inflation of 7.5% in April in the eurozone, EU President Christine Lagarde paved the way for an increase in July.
An increase (the first since 2011) whose extent is not yet known, but, according to the European Central Bank, is supposed to make it possible to get out of negative rates at the end of September. On Thursday, June 9, markets will turn their sights to Frankfurt, which should mark the end of net debt buybacks from the beginning of July, and possibly set their rate intentions.
However, it must be remembered that central banks are not the only ones that influence interest rates, the latter are caused by the balance between savings and investment. By reducing asset repurchase programmes, it will have less impact on the markets and therefore on interest rates, especially the long-term.
► Is this “normalization” of monetary policy desirable?
absolutely yes. The previous situation, in which central banks kept the economy on life support in hopes of combating deflation, was considered unsustainable because it was detrimental. We tend to forget that low interest rates poison the economy. It leads to ineffective investment choices and fuels speculative bubbles.” recalls Philip Wachter, chief economist at Ostrum Asset Management.
Moreover, for a central bank, setting zero or negative rates is tantamount to depriving itself of any leeway to support the economy. So, of course, they have innovated a lot in recent years with unconventional policies, going so far as to expand their mandate to buy back public debt indirectly. But this support, considered essential in its time, today poses a real problem of credibility.
Since 2008, the creation of central bank funds has increased eightfold, without any impact on inflation. So we can now seriously doubt the ability of central banks to fulfill their mission of price stability. So thinks Gisabelle Kobe Soberan, lecturer at the University of Paris 1-Pantheon-Sorbonne.
► What are the main risks to the economy?
For now, the risk of inflation is likely to be more important than the risk of higher interest rates. In fact, as long as real (inflation-adjusted) rates remain negative, economists believe they will not affect activity, unlike inflation, which slows consumption. According to Bred’s General Manager, Olivier Klein, “Interest rates will stop heating up already overheated activity when nominal rates are roughly equivalent to growth rates.”
So the whole question is how far central banks are willing to go to fight inflation, and whether they can really raise their rates enough to bring them back to their 2% target, without causing a recession. The game is subtle and requires special skill to prevent inflation expectations from slipping.
Right now, everyone is careful not to utter the term “stagnation,” which instead calls the term “stagflation” (a combination of weak growth and inflation), but recent signs are not encouraging. Earlier this week, the World Bank also lowered its growth forecast for 2022, from the 4.1% forecast in January to 2.9%.
“If interest rates rise without any effect on inflation, the risk is not only of slowing activity, but also of bursting speculative bubbles.“,” Gisabelle Coupe-Superan thinks. It is indeed the other catastrophic scenario that is emerging: the scenario of the financial crisis caused by the withdrawal of liquidity from the markets. “When the tide goes out, you see these people bathing naked.” American billionaire Warren Buffett said in 2008.
► What will be the consequences for countries?
With interest rates rising, concerns about the sustainability of public debt have resurfaced. In six months, the French 10-year bond rate rose from 0.2 to 1.8%, its highest level in ten years. Recently, the Bank of France alerted the government to the state of public accounts, recalling that after ten years, a 1% interest rate increase would represent an additional cost of approximately €40 billion per year, or the equivalent of defence. income.
But there again, we must be right. “As long as inflation remains above interest rates, the issue of public finances is not central,” Xavier Ragot, of OFCE thinks. With good reason, inflation, which makes it possible to increase GDP and increase state revenue thanks to excess tax revenue, could in theory be good news for public finances. In the short run at least, price hikes appear on the bill only after a certain period of time, under the influence of slow renewal of debt.
In the eurozone, the concern is actually more about the ability of countries to survive in this turbulent period, at the root of the deep rifts between low-debt and high-spending countries. In addition to showing very different levels of debt (113% of GDP in France at the end of 2021, 69% in Germany, 151% in Italy), different countries have implemented measures to protect households (tariff shield) which has completely It leads to an explosion of inflation levels within the euro area, increasing tensions and igniting fears of an explosion between countries.
► And for individuals?
Everything here again depends on the relationship between rising interest rates and inflation. In theory, higher interest rates are good news for the saver, who sees their savings as better wages, and bad news for the borrower, who sees the cost of their mortgage increase. But when inflation rises, savings are eroded, as well as the remaining capital which has to be repaid to the borrower… Gains and losses reverse. Provided that higher rates do not lead to a downturn in the real estate market.
“For this reason, in an inflationary period, the question is not raised in terms of rising rates as compared to falling incomes of the borrower, whose wages are seldom in line with inflation,” Philip Crevel, of Cercle de l’Epargne, explains. According to projections by the European Commission, real wages – that is, adjusted for inflation – should fall this year, leading to losses in borrowing power.
For now, mortgages remain at high levels, indicating that the (still moderate) rise in rates has not yet affected households’ ability to borrow. But real estate experts confirm this: more and more French people are being denied access to property, especially due to the scissors effect of high interest rates, keeping usury (the maximum rate at which banks can lend) to low. levels. To improve access to the property, Percy also plans to fix this rate of erosion.
► And for businesses?
Is higher rates likely to trigger a wave of defaults that were artificially suspended during Covid? The question arises more acutely as firms not only have to face the increase in the cost of credit, but a general increase in production costs. For weeks, they have been warning of the scale of the problems: soaring energy prices, a doubling of supply disruptions related to the war in Ukraine and restrictions in China, demand for ever-increasing wage increases…
“After squeezing their margins to the limit, we have more and more business owners telling us they can’t hold their prices anymore. The problem is that not all companies have the same pricing power,” Oliver Klein notes. By increasing their prices, the risk is also to reduce consumption, or to feed the inflationary cycle.
At the moment, the danger weighs above all on the zombie companies, those companies that banks have kept afloat thanks to the abundance of credit, even if the default rates are not exploding for the time being. The most indebted sectors, such as construction, transportation or distribution, are clearly more exposed, because, unlike households, companies can take on variable rate debt. “But also because French companies, unlike their German counterparts, are highly dependent on bank credit which accounts for more than 70% of their financing,” says Philip Wachter. Another weakness in this period of high rates.
In the face of inflation, the Bank of England (BoE) He was the first to raise the key interest rate last December.
The US Central Bank (Fed) followed suit in March, also raising its key rate for the first time since 2018. I repeated the process in May. On Friday, June 10, US inflation numbers are expected to be a good opportunity to see if this policy will pay off.
In May, the Central Bank of Brazil It raised the interest rate for the tenth time in a row since March 2021.
India’s central bank started on Wednesday, June 8 The second rate rise in two months.
In the face of slowdown in the country’s economy, On the contrary, the Chinese central bank cut one interest rate last May.