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Interest rate cuts won’t save Biden and Sunak

It's going to take more than a rate cut to save these two. Credit: Getty

May 9, 2024 - 2:45pm

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.


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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Alex Lekas
Alex Lekas
13 days ago

It’s cute that the article assumes Biden and Sunak are running anything.

Daniel P
Daniel P
12 days ago
Reply to  Alex Lekas

Biden is a Zombie…..maybe a better description is a drone.

Colorado UnHerd
Colorado UnHerd
12 days ago

As a longtime saver, I love higher interest rates, which should inspire all of us to save more and spend less (especially using credit cards) on non-essential items. Having dependable savings is good. Chronically worrying about debt is bad.
I’ve always had a hard time understanding why anyone would value spending over saving. But I don’t hold with the consume ever more/grow the economy mindset. It’s hard for me to see why anyone does, given that depthless consumption and endless growth are unsustainable economic philosophies that are ruining the planet without making people happier in any meaningful or enduring way.

Matt M
Matt M
12 days ago

Exactly! 5% interest rates seem ideal. Reduces malinvestment and rewards thrift and attracts deposits that can be lent to firms for investment. The obsession with getting back to 0% interest rates seems suicidal to me.

Peter B
Peter B
12 days ago
Reply to  Matt M

It’s crazy.
The article (which I otherwise like) suggests that lower interest rates are a sign of economic health. And yet, the record low interest rates were introduced – and held low for far too long – for exactly the opposite reason !
Agree we need sensible interest rates and that something around 5% is reasonable. We used to do just fine with that. That would also limit house price inflation – for which over-cheap money is a major driver.
The article is – I think – correct that governments and central banks can’t buck the market long term rates forever.

Steve Jolly
Steve Jolly
12 days ago

No offense. I happen to agree about saving and not being drawn into consumerism, which to my mind serves the interests of wealthy aristocrats at the expense of ordinary people. Still, I’d caution you against throwing around phrases like ‘ruining the planet’ as justifications. The people who talk of humans ‘ruining the planet’ too often tend to go well beyond rhetoric and use it as an excuse to impose their preferred lifestyle on others. Besides, what constitutes ‘ruining the planet’ vs an ideal state is an entirely subjective judgement. Some people might prefer a hyper-technological reality where the entire surface of the planet is one giant cityscape with a controlled climate managed by artificial intelligence and the population is sustained by technological means of sustenance rather than depending on fickle nature with its random fluctuations, unpredictability, and the violent conflict of the struggle for survival. That certainly isn’t possible at current levels of technology, but it might be in the future. Who am I to tell them their view is wrong or the sort of world they prefer is morally wrong? Nobody that’s who. My ideal is no more valid than anybody else’s. Not saying you’re necessarily one of those types, but I’d choose my words more carefully. You’re implying moral judgements you may or may not have intended.

J Bryant
J Bryant
12 days ago

For me, this article was a useful, concise tutorial on interest rates. It does seem, though, that whatever the long term consequences, a short term rate cut before the US and UK elections is all that Biden/Sunak need or care about. People will taste the short term sugar before the long term vinegar.

Michael Cazaly
Michael Cazaly
12 days ago

Of course ageing populations require public services…those who could have saved or inherited in order to look after themselves in later life were heavily taxed…so they couldn’t…

J Boyd
J Boyd
12 days ago

Associating higher interest rates with Truss’s policies betrays either economic illiteracy or a willingness to believe a biased media.
Interest rates are high because the response of central banks and governments made higher inflation inevitable.
They’re the natural consequence of QE and printing money.

Daniel P
Daniel P
12 days ago

The Fed will not be able to cut rates until next year. Guessing maybe March at the earliest.

Fiscal policy is at odds with monetary policy. So long as the government keeps printing new dollars at the rate of $1T every 100 days, inflation is going to keep going, Fed takes its foot off the brake and it will take off like a rocket.

The new budget year starts in October. The budget will be a Biden/Dem Senate budget. Meaning there will not likely be meaningful cuts for next year. Even if Trump were to get elected the first budget he could effect would be the following year.

William Cameron
William Cameron
12 days ago

Abnormally low interest rates are bad. They shift wealth from workers to rich asset holders. They make houses too expensive for young families . They allow poor businesses with poor returns to function.
Base rates should be the long term average- around 7%