Interest rates continue to rise in the wake of inflation

They are becoming increasingly scarce: government bonds with negative interest rates. With high inflation seemingly never ending – driven in part by the Russian invasion of Ukraine – investors want higher compensation in the form of higher interest rates. On Monday, the interest rate on Dutch (and Belgian) government bonds with a maturity of two years briefly broke through the zero limit – for the first time since 2014.

The Dutch two-year rate follows the five-year rate, which turned positive again in February, and the ten-year rate, which has been above zero since the end of January. This marks the end of the long period in the financial markets in which investors invested in most bonds.

It reflects rising inflation fears. In February inflation in the Netherlands was 7.3 percent, in the eurozone 5.9 percent. The war in Ukraine is pushing up the prices of energy, raw materials and food. Investors expect central banks to raise interest rates to dampen inflation. The higher the interest rate, the more expensive it becomes for consumers and businesses to borrow. And the more attractive it becomes to save. All this slows down economic activity, and thus price increases. Capital market interest rates are anticipating higher interest rates from central banks expected by investors.

The rising capital market interest rate has an impact on mortgage rates in the Netherlands, among other things. Since October last year, interest rates on mortgages with fixed-rate periods of ten and twenty years have risen by a full percentage point, financial advisor Van Bruggen Adviesgroep reported Monday in a newsletter. The rate for ‘ten-year fixed’ with a national mortgage guarantee has risen from 1 to 2 percent since October (the low point of mortgage rates in the Netherlands). For ‘twenty-year fixed’, the interest rate went from 1.33 percent to 2.36 percent now. “Only in the euro crisis have we seen a comparable increase in such a short period of time,” said Van Bruggen, referring to the 2011-2012 debt crisis in the eurozone.

Further increase expected

Interest rates are expected to rise further in the financial markets. The value of exchange contracts on the money markets indicates the expectation of four rate hikes by the European Central Bank (ECB) within one year. In March 2023, the ECB deposit rate, currently minus 0.5 percent, would be plus 0.5 percent. Whether it will come to that is, however, highly uncertain. Very difficult for the ECB and for other central banks is that economic growth is being held back by the war. An interest rate hike that is too rapid can give the economy a blow, hesitating too long with an interest rate hike will push inflation up further.

In the United States, where inflation stood at nearly 8 percent in February, a worrying phenomenon is emerging in the financial markets: long-term interest rates are now in many cases lower than shorter-term interest rates. Normally it is the other way around, because the longer the term of a bond, the higher the risk (and therefore the interest rate) for the investor. If it’s the other way around, it often indicates near-term recession danger. On Monday, the yield on five-year US government bonds was slightly higher than on thirty-year.

It is by no means certain that there will be a recession in the US – but that would give the Fed, the US central bank, a lot of headaches in inflation time.

Interest rates continue to rise in the wake of inflation
Source link Interest rates continue to rise in the wake of inflation

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