Tuesday, 3 November 2009

Predicting Interest Rates Burst

The central bankers have driven their interest rates policies based inflation targets.The European Central Bank (ECB) target is 2%.

However, with globalization and massive speculation on financial markets, can we really be confident that central bankers are in control? For example, petrol price currently is mainly driven by financial institutions/speculators hedging against the fall of the dollar instead of reflecting the real fundamental of the global economy.

In addition, they clearly underestimated asset prices speculation (housing and stocks) effect on the real economy and its effect on consumers (wealth effect) or choose to completely ignore it.

Now here is one over many scenarios (see chart below) on what could happen to interest rates. This is based on the fact that central bankers have currently no choice than to support a very weak economy in which many actors are deleveraging (paying of their debt under low interest rates). They are taking big risks where we could see interest rates burst into an explosive and fast manner.

To check the inflation in Europe, here are links inflation indicators:

- ECB Inflation Dashboard
- 3-Month Euribor
- Government Bonds

PS: I have added a reference on the right menu of the blog


Andrew said...

How will it be that probably the majority of people who are barely able to afford to live now will suddenly begin paying higher prices so that prices can explode?

With rates so low tiny rate rises will have a massive influence upon spending. Most people today have no idea what a high interest rate will feel like - all they know is easy money. It is still part of the culture - there is no pain yet for the in debt employed.

HousingFinland said...

In fact the chart shows interest rates (3-Month Euribor). So it is about interest rate burst (I corrected a possible confusion).

In fact in the next few years I cannot see a scenario where employee have wage bargain power, on the contrary. Income will stagnate or come down in real term in the next few years.

However inflation is related to monetary growth as Friedman put it:

"Inflation is always and everywhere a monetary phenomenon.
—Milton Friedman, A Monetary History of the United States"

So there will be danger that monetary growth will exceed real GDP growth for a prolonged period hence endanger the control of inflation.(More could be said with that regard and more analysis and time will be needed to have a better understanding)

HousingFinland said...

You could check the following link that tells how interest rates could jump quite suddenly even if inflation is low.

"In a year of low inflation, bondholders have suffered more than $1 trillion in losses. Here's why it happened, and could happen again." - 1994


At the end it is really a monetary phenomenon. Who would like to lend to a country that have a currency that is not credible or a country whose deficit in not in control?

Andrew said...

i cant remember now but most people misquote Friedman with this quote by taking it out of context. His context was people blame oil prices or unions or food prices but in fact without more money, inflation of everything is impossible.

But it does not matter how much money you have in bank accounts you cannot get inflation unless people are spending. Friedman knew that and of course he knew about velocity of money.

I have by the way just had a drink! I think we need to catch up and continue soon. Did you get my SMS with my email address?

The USA might be the most loveless nation on earth (mother theresa) but without a consuming US many countries are going to be going nowhere, so in that context the deficit does not matter until the rest of the world is ready for a world without US consumption.

The world loves to sell its stuff to America. Without America china would be nowhere, without china Finland would be where??

I dont see how you isolate the USA from what is really a world or a human thing about wanting.

The US remains the most powerful country on earth. the problem for america is mainly about some kind of adjustment so that the ordinary people in America are part of the wealth of America rather than the elite moving endlessly production to some place other than America. Fat americans are going to have to learn to work a bit harder and consume a bit less and maybe the rest of the world has to be a bit poorer also when that happens

HousingFinland said...

I will be going on holiday for a while (2 weeks), but I have scheduled post I have never published because of time (unfinished) or thought there were unteresting... check them out there will appear every 2-4 days...

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