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AB 2000 studies

Alain Boublil Blog


Interest rates : The end of the increases

The United States, United Kingdom and eurozone central banks have announced they kept their basic rates at the current level. These decisions have been justified by the significant slowing of inflation which has been observed since the end of the Summer with in September prices increases came back year on year to 2.9% in the euro zone and to 3.7% in the U.S. The executives of these institutions have clearly specified that didn’t rule out new increases in the coming months because they considered that we were far from the objective figuring, explicitly or implicitly, in their mandates to bring down inflation at a level near but under 2%. But this prospect is very low likely.

This convergence occurs in a different economic context between the two sides of the Atlantic. Growth seems to be sound in the U.S. with an annualized rate of 4.9% in the 3rd quarter which would allow to overpassing by large 2% during the full year. To the opposite, due notably to the crisis which affects Germany whose economy is stagnating for near a year and the weakness of the French growth which could be inferior to 1% in 2023, the eurozone is experiencing a near-stagnation. The decisions of the two central banks so result from different motivations.

The U.S. have a low unemployment rate (3.8%) and it is the household consumption which is supporting growth since the beginning of the year. The rates increase has been spectacular because the Federal Reserve basic rate has been brought until 5.25% when it was near zero at the beginning of 2022. That has not yet provoked a recession, as it was the case, for instance, at the end of the Seventies with Paul Volcker monetary policy. One of the reasons lies in the weak repercussion of the central bank action on mid and long-term rates which, them, have much less increased and are today lightly inferior to 5%. The rate curb is almost flat which is favorable to investments but dangerous for the banking system whose margins are partly based on the spread between short and long-term rates. Despite this context, it has been decided to have a break.

The situation is quite different in Europe. If the European Central Bank has increased as strongly its basic rates as the Federal Reserve, it had launched before two Assets Purchase Programs which have allowed the mid and long-term rates to remaining clearly inferior to short-term rates. France is issuing bonds since the beginning of the year at an average rate of 3.01% when the ECB basic rates are above 4%. That situation will go on because the institution will reinvest the product of the reimbursed bonds coming at maturity until the end of next year. But the observed progresses on inflation do not come from the monetary policy but from the joint consequences of a basic effect and of external factors.

Strong energy prices increase occurred in 2022 after the invasion of Ukraine by Russia and has generated the first inflationist wave for thirty years; the phenomenon did not happen again in 2023. Prices which had strongly risen did not came back at the level observed before the invasion but they have not anymore increased again; international tensions have contributed to the disorganization of the supply chains which has been a second factor of costs increase and which has been transferred to consumers. But the enterprises are progressively adapting themselves to this new context which will have as an effect to soften the pressures on prices.

The recent period has so seen an increase of the growth gap between Europe and the U.S. but, as regarding inflation, that gap is not the consequences of the monetary policies. The U.S. become again, thanks to the oil and natural gas shale production an exporter of fossil fuels at a time when Europe, by large due to the German mistakes, saw its essential supply sources cut and its prices strongly increasing. The country has also taken profit from the exceptional successes of its high-tech enterprises, the GAFA, Europe cruelly is lacking.

This growth gap risks to increase again in the future with the adoption by the U.S., as a total break with its very liberal past, of public aids programs in the industrial sectors with as an exposed objective to reorient the investments to their territories. These aids can have very various forms: subventions, tax advantages, privileged financings. In the same time, Europe is unable to abandon its twin religions of competition and of banning State aids which just contributes to weaken its enterprises to the greatest profit of their American and Chinese competitors.

That transformation in the international relationships in a context of political instability and with permanent threats of confrontations has not been ignored by the central bankers which have certainly taken into accompt othe limits of their action: the same policy on both sides of the Atlantic has produced completely different results on growth which put into doubt its efficiency. To the opposite, it is not possible to ignore the financial consequences of the monetary policies. Diverging measures regarding interest rates would immediately provoke currencies fluctuations which could be brutal and affect the major economic equilibriums of the related countries. In Europe, a euro fall against the dollar would make heavier the energy bills and would make inflation rebounding because oil and natural gas are paid with the American currency.

In the U.S. the economic context so doesn’t justify new interest rates increases but it must be also taken into account the political agenda. 2024 will be the year of the presidential election. An even more restrictive policy of the Federal Reserve could that time have heavy repercussions not only on household situation with an increase of unemployment but also on the situation of the banks health which are already fragile and on the evolution of the financial markets. That could provoke heavy discontent in the population and influence the result of the election.

In Europe, a pursuit of the rates increase would make heavier the public debts charge. But the ECB, through the launch in 2015 and in 2020 of the APP and PEPP programs has generated an increase of its balance sheet from 2 000 to 8 000 billion euros along with making easier the recourse of State-members to indebtedness. It would be a paradox that, in an environment of economic stagnation which already weights on fiscal and social receipts, the Frankfort institution contributes to a degradation of the financial situation of the State through an increase of their debt charges, which would put them into difficulties.

It is so always possible that a rate increase occurs but it is almost sure that this will not occur. World has changed. Inflation causes are not anymore as in the past and the consequences of the monetary policies are not anymore limited to their effects on the balance between the supply and the demand inside a country due to globalization of the financial exchanges. Today and tomorrow, the results which could be expected from the use of the monetary tool will so depend at first from the taking into account by their executives of the real consequences of their action.