What About Short-Term or Policy Rates?



Short-term interest rates—such as the U.S. federal funds rate, the Bank of England’s bank rate and the ECB intervention rate—can exceed long-term rates, but when this rarely occurs, the gap is usually small. Short-term rates that are higher than long-term rates are referred to as a “yield-curve inversion,” which causes problems for the banking system and is often a precursor of recessions. When an inversion does happen, or when short-term rates approach but do not pass long-term rates, it is not long-lived.

This effectively means that the predictions for nominal long-term rates put a ceiling on future policy rates. They may even be lower depending on the stage of the economic cycle in any given year (policy rates are usually below long-term rates when output is running below capacity).

At present, the U.S. Fed and the Bank of England are keen to push policy rates up if only to have scope to reduce them again if another recession hits. Our analysis implies that policy rates are unlikely to exceed 2.9% in the U.S., 2.5% in the U.K. and 2.0% in the euro area in 10 years' time and may be lower.

Policy rates in the U.S. may go up substantially over the next year or two, but part of this will be cyclical and rates will ease back if the economy slows. The Bank of England may want to increase policy rates, but attempts to do so are being constrained by Brexit-related uncertainty and weak economic growth. It may be after the final Brexit settlement becomes clear before substantial normalization happens.

Forward guidance by the ECB indicates that any rise in policy rates will be very gradual and the low levels of core inflation will support the doves on the ECB in future decisions.


"Our analysis implies that policy rates are unlikely to exceed 2.9% in the U.S., 2.5% in the U.K. and 2.0% in the euro are in 10 years' time and may be lower."

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