Politicians facing tough re-election campaigns this year are holding out hope that central banks may ride to their rescue, cutting interest rates in time for them to tell voters things are improving. British Prime Minister Rishi Sunak is clearly holding out for just such a Hail Mary pass to bolster his message that the economy has turned a corner. US President Joe Biden has gone further, telling Americans that rate cuts are coming this year.

But if this week’s action on bond markets is anything to go by, they may want to curb their enthusiasm. This afternoon, the Bank of England kept rates at 5.25% while suggesting there will be a cut in the summer. Yesterday, Sweden’s central bank became one of the first to cut rates. It started what many expect will be a year of cuts to interest rates across the West. Central banks in Europe, Canada and now Britain are all expected to follow suit by starting cycles of easing soon, and it’s possible that the US Federal Reserve, despite the strength of the American economy, may join the group by year’s end.

It wasn’t a big move, just a quarter of a percent reduction, as expected. But in response, the yield on Sweden’s 10-year government bond, the benchmark for many interest rates like mortgages, didn’t follow it down. Actually, it rose slightly. This is probably a sign of what’s to come.

To an economist, the fact that long rates would rise when short rates are cut isn’t surprising. Lower interest rates in the short term can, to the extent they stimulate economic activity, produce higher inflation in the long term. Accordingly, investors may demand a higher return on long-dated bonds to compensate for the risk of inflation later eroding the value of their money. Add to that the fiscal trajectories of Western countries, where the demand for public services among ageing populations could outpace economic growth, and bond investors will continue demanding higher rates on loans to governments.

But while economists get this, it may come as a nasty shock to many ordinary folk, to say nothing of their leaders. There’s a widespread belief that central banks determine interest rates. That’s only true of short-term rates. Longer-term rates are set in the market, by investors who can drive down bond prices in order to raise interest rates. Developing countries have long known this, as the hyperinflation that once characterised some of them meant bond rates far exceeded central bank targets. But it’s a new experience for Western countries, which recently took the place of third-world states in the ranks of the profligate.

In extreme circumstances, central banks can intervene to manipulate long rates. That’s what quantitative easing did: central banks used their ability to create money to buy government bonds, driving down yields. But the current circumstances hardly look extreme. Some asset prices may be plunging; the economy isn’t.

So we may be moving into a period in which short-term, variable rates come down but the rest stay elevated — or even go higher. In a country such as the US, where the pain of higher interest rates is felt acutely in credit card bills, the reduction in short-term rates may still, if it comes in time for the election, provide some relief for Biden.

But where long-term interest rates matter most to voters, changes to central bank policy might not make much difference. The voters that Sunak needs to win back are largely homeowners, who still associate raised mortgage costs with the fiasco of the Liz Truss budget, and may not get much relief soon. To use the muddled metaphor of a recent British home secretary, this may be a hole he cannot dig out of.

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John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).

jarapley

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