Ultra-low interest rates were only ever meant to be a short-term move, to stimulate investment. Where is the normalisation we were promised?
This has been a year in which, amid the many surprises that have made mugs of forecasters, the big central banks have contrived to make mugs of themselves. Why? Twelve months ago, we seemed to have embarked on a steady glidepath towards the ‘normalisation’ of interest rates and, indeed, of monetary policy more generally.
Back then, the US Federal Reserve looked set for at least a couple more rate hikes this year, saying in its December 2018 statement that “some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity”. Having embarked on a reversal of its post-crisis quantitative easing (QE), it seemed set to persist in doing so.
It was not alone. Although the Fed was further along the normalisation path than others, other central bankers were singing from the same hymn sheet. At the Bank of England, Mark Carney looked forward to “limited and gradual” rate rises, once the pesky uncertainty of Brexit had been got out of the way by 29 March. The Bank had also brought down the level of official interest rates at which it could begin to reverse its QE to just 1.5%. Even the European Central Bank did not demur greatly, foreseeing a long period in which its interest rates would be on hold and calling a halt to its QE in December last year.
It has not, of course, panned out anything like that. The Fed’s bullishness on interest rates turned out to be misplaced, and soon it was turning from raising rates to cutting them, with its chairman Jerome Powell doing little for relations between the central bank and the White House by laying much of the blame on Donald Trump’s trade wars. The Fed, having dipped a toe into the water by beginning the reversal of its QE, called a halt to that too.
The Bank of England, frozen into inaction by Brexit uncertainties, maintained its “limited and gradual” language on rate rises until the autumn, before finally conceding that, irrespective of the Brexit outcome, the next move in rates was likely to be down. The ECB got there first, cutting one of its rates, the deposit rate, to -0.5% – yes, that’s minus 0.5% – and resuming its QE programme from November. The Bank of Japan has had negative interest rates since 2016.
Normalisation failed, and central banks are back almost where they started in the wake of the global financial crisis.
Rates, it seems, are stuck at historically low levels and those who thought we had seen the end of QE were premature in doing so. We shall see what happens in 2020, but the outlook is very different from a year ago.
Investors, including investors in property, probably do not see too much wrong with this. There is not, after all, much inflation around – even an attack on Saudi Arabian oil installations did not push the oil price up on a sustained basis – and economic growth is subdued. Anything that keeps markets and asset values strong surely has to be welcomed.
Perhaps, but maybe it should also make us feel uneasy. Two noted brains argued recently that very low interest rates, and even more so negative rates, may do more harm than good. They argue that central banks may already have reached what is known in the jargon as the ‘reversal rate’, the point at which ultra-loose monetary policy ceases to achieve its main purpose – which is to expand the economy – and instead becomes contractionary. The two are in a good position to opine on this. Huw van Steenis is a former adviser to Mark Carney at the Bank of England and is now a senior adviser at UBS, the bank. Charles Goodhart, a professor of economics at the London School of Economics, has a long Bank of England pedigree and was a founder member of its monetary policy committee.
For economists, cutting interest rates has the desired effect, however low or negative they go. But that, according to van Steenis and Goodhart, ignores the realities of the financial system. As they put it in a recent article: “Like steroids, unconventional policy can be highly effective in short dosages, but just as long-term usage of steroids weakens bones, so below-zero rates can weaken the financial system. Negative rates erode banks’ margins and distort their incentives. They encourage lenders to seek out opportunities overseas rather than in their home markets.”
It is not just the banks. Institutional investment is distorted by negative yields on government bonds The safe-haven appeal of government bonds diverts investment by pension funds and insurance companies away from other assets, including property. The lower the yields on such bonds, perversely, the more that institutions have to invest in them to achieve their mandates. With $17trn (£13.4trn) of negative debt out there, low rates are a significant drag.
Van Steenis and Goodhart are not the only ones arguing this case. Larry Summers, the eminent economist and former US Treasury secretary, recently wrote of the “monetary black hole” of negative interest rates and called for governments to spend more as well as to introduce new incentives for the private sector to invest. The ultimate cause of low or negative interest rates is that there is a surplus of savings over investment.
It was not meant to be like this, of course. Ultra-low official interest rates, and lower government bond yields as a result of QE, were intended to stimulate investment elsewhere. But then neither were intended to last for as long as they have done.
What does this mean for property? The forces keeping interest rates down are those that are preventing the global economy from growing more rapidly and making businesses more cautious about investing. Optimists would argue that this is just the temporary effect of Donald Trump’s trade wars, which will pass when they are over. Pessimists like Summers fear that we have entered a period of long-term weak growth, or ‘secular stagnation’.
Other issuers can, of course, also take advantage of ultra- low or even negative rates. A few weeks ago Jyske Bank, a Danish lender, issued a ten-year mortgage bond at a negative interest rate of 0.5%. It has not yet started a trend.
We shall see one bonus for property investors: very low interest rates, as set by central banks and government bond markets, set the bar very low for property returns. According to Savills, prime yields range from 3.75% on West End offices, to between 4% and 4.5% on industrial properties, 5% on high-street retail and 6.5% on retail warehouses. In the context of low or negative interest rates, that is not so bad at all.
