OPINION
For 30 years both property and equity markets have sailed along on the fair winds of ever lower interest rates.
Until now.
After the post-Covid surge in inflation and a dramatic series of central bank hikes around the world, the good times of super-low rates are over.
But are they gone for good?
With the Official Cash Rate in New Zealand tipped by some to rise as high as 6 per cent, it’s clear investors can no longer count the kind of benign conditions they’ve been used to.
What’s less clear is whether this is just a short corrective period to rebalance the economy after all that Covid Stimulus, or whether this is a return to the kind of higher interest rates that were once the norm.
It’s worth considering what we mean by low rates.
The price of borrowing certainly feels high, relative to what we became used to in the years after the GFC.
But for anyone over the age of 50, it probably isn’t so shocking.
Since the Kiwi dollar was floated in 1985 the New Zealand wholesale interest rate has averaged 6.74 per cent, according to Trading Economics.
That average is elevated by a significant period of high rates through the mid-1980s.
In the boom years through to the 1987 stock market crash asset values soared and so did inflation.
Despite inflation numbers looking worse now than they have been since the 1980s interest rates haven’t yet been anything like as bad.
Interest rates surged well into double figures in the 80s. Some mortgage rates were above 20 per cent by 1987.
The decline in interest rates since those peaks has been historic and not unrelated to the increased focus on inflation that central banks brought to bear through the 1990s.
In 1999 the Reserve Bank introduced the Official Cash Rate (OCR) as it sought to better target inflation.
Since the OCR was introduced it has averaged 3.84 per cent.
So by the standards of this century at least, we can call this an era of high rates.
Two big events the GFC and the pandemic have pushed down that average - and probably our expectations since 2008.
Central bank policy has been to slash rates and stimulate through downturns.
The Reserve Bank took it to what seemed like a very low level in 2009, at 2.5 per cent.
It never really recovered and after more than a decade of deflationary pressure the pandemic shock saw it slashed to its record low of just 0.25 in 2020.
The question now is not so much: will normal service resume once we are through this cycle, but, what is normal?
Some economists, like Nobel Prize winner and NY Times columnist Paul Krugman, have argued that once the post-pandemic balance is restored and inflation subsides, there is no reason why see interest rates won’t dip back to the low levels of the 2010s.
Krugman’s argument is primarily based on demographics.
“There were fundamental reasons interest rates were so low three years ago. Those fundamentals haven’t changed; if anything, they’ve gotten stronger,” he writes in the New York Times.
“So it’s hard to understand why, once the dust from the fight against inflation has settled, we won’t go back to a very-low-rate world. The low rates in the last decade were the endpoint of a 30-year downward trend for interest rates.”
Those fundamentals, he says, are an ageing population and relatively stable technological progress.
In the wake of the baby boom and long period of post-war economic growth the world has seen birth rates fall.
In most of the Western world, the population is ageing.
Japan is often seen as the poster child for this phenomenon, which is expected to spread across the rest of the developed world,
With ageing population demand generally decreases in an economy.
Put simply, as people age, they tend to spend less, leading to a decrease in demand for goods and services.
That can lead to excess supply and lower prices, resulting in deflation.
Older people are also more likely to save more money as they approach retirement.
That can reduce consumption and decrease demand which adds to the deflationary pressures.
The other issue is that with more retirees and a smaller percentage of the population in the most active end of the workforce economies can experience lower productivity.
That can lead to lower economic growth and reduced inflation.
Older people are certainly more active, working longer and spending longer these days.
But the broad structural trend is still there and like to be a powerful economic force in the next 20 years.
I’m not as confident as Krugman that inflation will subside back to the near-zero lows we saw last decade.
He also seems largely unimpressed with the productivity gains that could be coming via new technology such as AI.
Most of the hype about AI in the past year has been about the dystopian threat it poses to society - the stuff we’re used to from sci-fi movies.
But it should also bring big efficiency gains to businesses like manufacturing and logistics.
We could yet see an AI-fueled economic boom, of the dot.com variety, rapidly boosting growth.
Locally the consensus has economists expecting to see inflation falling back into the 1-3 per cent safety zone by the end of 2024.
That suggests we should expect to see the Reserve Bank bringing the OCR back down sometime next year.
In the context of the past 30 years, it seems to reasonable to assume that rates will settle back to relatively low levels.
The Reserve Bank currently still sees the neutral rate (the level the OCR should be if the economy is stable ) at between 2 and 3 per cent.
We shouldn’t expect interest rates to go back to near zero. In fact, we should hope they don’t.
Hopefully, we’ll get a few years without a major crisis and the need for radical central bank stimulus is behind us for a while.
Low-interest rates are good for capital markets because they encourage borrowing and investment by companies - that drives productivity and growth.
But if they are too low that is really just a symptom of a deflationary economy where confidence in the future is low.
The fact that low rates also make equity market investment more attractive than holding cash is a bonus - but it shouldn’t be a crutch.
We don’t need another bull market pumped up on central bank stimulus. We need companies to invest and grow their value with real earnings.
Liam Dann takes a deeper dive into the week's economic news