What is the Future Path of Real Long-Term Interest Rates?



The outlook for long-term interest rates depends on what happens to the key variables outlined in this analysis: demographics, GDP growth, QE and expected inflation (for nominal rates). Our forecast of these variables is as follows:

  • Real and nominal long-term interest rates likely will increase compared to end-2017 levels.
  • The declining share of world population aged 40 to 54 will cause an approximately 20-to-30-bps increase in interest rates over the next 10 years (Figure 8).
  • While central banks’ balance sheet normalization (quantitative tightening) will also have an upward effect, any increases likely will be limited and well below the estimates of normalization hawks or the consensus forecasts.
  • The future of QE (central banks’ balance sheet normalization) is the hardest to predict. QE is meant to be temporary, but the pace at which it will be withdrawn is not clear and it will be rapidly reintroduced if there is another recession.

The tables below show various possible outcomes for long-term interest rates over the next 10 years. Being precise about a single year is difficult. Cyclical changes, economic policy changes and political risk can alter these predictions, so this analysis is best considered as a general long-term outlook.

FIGURE 10: REAL LONG-TERM INTEREST RATES

Fig10

*Full normalization is defined as interest rates returning to their 2000-2007 average.
Source: CBRE, August 2018, Consensus Economics, April 2018.

FIGURE 11: NORMAL LONG-TERM INTEREST RATES

Fig11

*Full normalization is defined as interest rates returning to their 2000-2007 average.
Source: CBRE, August 2018, Consensus Economics, April 2018.

Conclusions

Concerns about rising real and nominal long-term interest rates are overblown. The likely increase in rates will be less than the consensus of economic forecasters and they will level off at well below pre-GFC levels.

A 100% normalization of central banks’ balance sheets would not dramatically affect these findings. In the U.S., full normalization of the Fed’s balance sheet would push real long-term rates to 1.2% and nominal rates to 3.2%—still well below the consensus forecasts. In Germany, a full reversal of the European Central Bank’s QE program would be more serious and would push nominal and real long-term rates close to the consensus forecasts. The U.K. would be somewhere in between, with real and nominal rates closer to but still below the consensus. We emphasize, though, that full central bank balance sheet normalization is unlikely over the next 10 years.


"Concerns about rising real and nominal long-term interest rates are overblown. The likely increase in rates will be less than the consensus of economic forecasters and they will level off at well below pre-GFC levels."

While the focus of this analysis is on the U.S., U.K. and Germany, its general conclusions apply to other developed economies unless political or government default risk intervenes. Japan is a special case.  The Bank of Japan is effectively using QE to target zero nominal long-term interest rates. While this policy persists, real long-term rates can only go up if inflation expectations fall. This is not impossible though it looks unlikely over a sustained period. 

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