Cost of borrowing will probably stay elevated for foreseeable future, making it harder for governments to service debts
What a difference two years make. In 2021, when interest rates were near zero in the US and the UK and slightly negative in the eurozone and Japan, the consensus was that they would remain low indefinitely. Astonishingly, as recently as January 2022, investors put the probability of rates in the US, eurozone and the UK rising above 4% within five years at only 12%, 4%, and 7%, respectively. After adjusting for expected inflation, real interest rates were negative and projected to stay that way.
In fact, despite the US Federal Reserve and other central banks’ aggressive monetary tightening, real interest rates remained significantly negative until late 2022. Moreover, long-term rates increased more moderately than short-term rates: by October 2022, the yield curve had inverted, signalling that financial markets were expecting central banks to reduce short-term rates in the near future. This sentiment stemmed from the widespread expectation that the US and global economies would enter recession.
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