Investors on edge amid uncertainty around inflation

Era of rock bottom borrowing costs may be coming to an end with interest rates set to rise

A bit of inflation is a good thing. The European Central Bank wants to bring the euro zone rate to 2%, allowing some kind of normality to return to interest rates. Photograph: Chris Ratcliffe/Bloomberg

A bit of inflation is a good thing. The European Central Bank wants to bring the euro zone rate to 2%, allowing some kind of normality to return to interest rates. Photograph: Chris Ratcliffe/Bloomberg

 

In the summer of 2013, the US Federal Reserve Board announced that it would start to withdraw – or taper – support from the bond market which had been intended to help the economy to recover from the financial crash.

Bond prices tanked and the US 10-year interest rate jumped from 2 per cent to as high as 3 per cent by December.

Now, with rising inflation pushing the Fed to taper again – and half of the Fed governors expecting interest rates to rise as early as next year – investors are on edge again and bond interest rates are edging higher.

There are few more important trends for the Irish economy. Irish 10-year bond yields, or interest rates, swung higher in May but dropped in the summer as bond rates across the world collapsed. Now they are edging up and, while this is insignificant in terms of any new borrowings right now – rates are still just above zero – the debate is now on about where this goes next. Are we, as had been expected, looking at a prolonged period of low interest rates?

While some of the price pressures pushing up inflation rates may be transitory, pressure on supply chains due to the pandemic appear to be persisting, leading to rising costs – now likely to be passed on to consumers. And energy costs remain stubbornly high with threats of more to come.

If this starts feeding through into general wage growth, then central bank concern will rise about inflation becoming embedded again. A bit of inflation is a good thing, of course. The European Central Bank wants to bring the euro zone rate to 2 per cent, allowing some kind of normality to return to interest rates.

It will be a while before this all plays out – after all we have never had a pandemic in modern times and don’t know what to expect. But in the meantime, watch out for the tantrums as investors wonder whether the bets they placed on a world of permanently rock bottom borrowing costs are now looking quite so smart.

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