Interest Rates to Rise

Expectations re that low interest rates are here to stay. There is now a body of thought that thinks they could rise much sooner and faster than many expect.

Interest Rates to Rise

Despite the insistence of Governments that interest rates will remain low for years to come, I have a growing belief they are set to rise - sooner and more rapidly than many expect.

That view is formed by taking an aerial view of where the world currently finds itself.

Before I explain further it is important that you understand there is a stark difference between official interest rates (which governments borrow at) and those available to the rest of us. One certainly informs the other but the reality is that banks need to attract deposits (bonds, bank accounts etc) in order to lend and the private 'lenders' demand a market rate of return on their money.

If competition for deposit funds is high, banks need to offer more attractive rates to remain competitive and those costs are passed on to borrowers.

Government borrowings operate in a similar manner but with some recent caveats. They have historically needed to sell bonds to institutions to fund their own excess spending. More recently they are selling those bonds to their own Central Banks in a version of money printing.

Even at the current very low interest rates, those government borrowings are becoming unsustainable.  In effect governments are borrowing money to pay the interest on previously borrowed money which is clearly not sustainable. They also borrow issue new borrowings to repay previous capital loans.

To avert that continuing scenario, there is a muted move by central bankers to turn government bonds into a form of perpetual bonds. That's a bond where the principle is never repaid, only the interest.

In such a case, the cash outflows are reduced and the government can continue to borrow. However, in order to attract buyers for those bonds, they will have to offer a higher return. Hence, if perpetual bonds come in, governments will eventually be forced to raise rates.

Right now, this scenario is most advanced in Europe because they are out of options to kick start their economy. It could actually happen as soon as next year!

So what does this mean for the rest of us?

To answer that, one needs to consider the competitive market. If government needs to offer higher rates to continue borrowing that requirement will inevitably flow on to the banks.

They'll need to attract deposits of their own to preserve their ability to lend.  

I think some banks are already anticipating this more competitive market as they seem loathe to commit to commercial lending with fixed rates of more than three years.

In some circumstances, they won't even offer commercial loan facilities for more than three years, preferring to revisit the credit market then. As someone who has been active in that market for several decades, this is the first time I have experienced that .

That's why I think the smart money is punting on rates rising in the years ahead. I suspect it could commence much sooner than most people expect.  

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