This will be the week of the turning point in interest rates. No, probably not here just yet, for while I would not completely rule it out, the balance of judgement remains that the Bank of England will wait until May before pushing up its base rate. But the European Central Bank has signalled strongly that it will increase rates tomorrow, and the mood seems to be shifting within the Federal Reserve towards higher rates too. Turning points are always hard to catch exactly, but this week feels as good as any to identify as the moment when the long climb back to normality begins.
What should we make of all this? If indeed this is right and the ECB pushes up rates by 0.25 per cent to 1.25 per cent, there will be people who argue that it is making an historic error: that they will be clobbering the weaker parts of the eurozone just when they are still flat on their back.
It is certainly true that if you are stumbling towards some sort of sovereign bailout, as is Portugal, than any rise in rates is less than kind. There is the inevitable problem in Europe that different parts of the region need different interest rates. During the boom years, places such as Ireland and Spain needed higher rates to curb their property booms, while Germany needed lower rates to boost home demand. Now it is the other way round, for it is Germany that is racing ahead.
This is not ideal, but we should be a bit suspicious of any suggestions that a rise in rates will be a catastrophe. It is inherently improbable that a quarter percentage point on short-term rates will have a huge impact, and while there will be further increases, by all historical standards money will still be cheap.
That point will apply even more strongly in Britain. We have even lower nominal rates, just 0.5 per cent, and much higher inflation. In real terms, that is allowing for inflation, our short-term rates are minus 4 per cent. That has costs. One is treating savers unfairly. Another is a weak currency. Thanks to a devaluation of the pound of roughly 20 per cent, the oil price in sterling terms is even higher than at its last peak. The fall in sterling, in part at least, is associated with these very low rates and the pound perked up a bit yesterday on the back of a good forecast for the service industries. What is worse – slightly higher mortgage payments for some people, or yet more expensive petrol for everyone?
The mood in the US is shifting too. Concerns about both the loose monetary and the equally loose fiscal policy are mounting. The language of the chairman of the Fed, Ben Bernanke, has become sterner. We will have to see how rhetoric translates into action, but as the economy strengthens, the case for what many see as artificially low interest rates correspondingly weakens. The world is getting back to normal.
That, surely, is the best way to view what is happening. We have come through an abnormal period, which called for abnormal policies. Whether those policies were optimal or a bit off-centre will be debated for generations. We are still too close to the whole mess to be able see it in any perspective. But there are some things we do know, and one is that negative real interest rates cannot be sustained in the long term.
The really interesting question is in what ways might the new normal be different from the old normal. Well one difference is already evident. This may be the turning point for interest rates in the developed world, with Europe leading the way, but China has just had its fourth rise in rates. So this is the first time ever that the upturn in the global interest cycle has been led by China.
Another way in which the new normal will be different is the prevalence of extreme events. We have in the past few weeks had a medium-sized oil producer, Libya, in effect shut down; we have inched closer to a sovereign default in Portugal; and we have had the catastrophe in Japan. Yet the financial markets have taken all this in their stride. I find this astounding. It could be that the markets are in cloud-cuckoo land. Has been known. Or it could be that the big positive story of the world recovery is robust enough to cope with immediate blows such as these. In other words, we are getting used to extreme events, however distressing they might be.
Looked at this way, the prospect of rising interest rates should not fill us with dread. The fact that they can be increased is itself a sign of confidence that Europe, then the UK and the US, are all increasingly participating in global growth. Rising rates are a signal of a return to health, not some vile punishment laid upon us by sadistic central bankers.
Figures that offer hope for everyone
The OECD forecasts that came out yesterday confirm the broadening of the economic recovery noted above. Its reports are always good conventional assessments of what is happening, and they deserve to be taken seriously.
These new forecasts confirm that the Group of Seven large developed economies, taken as a whole, are growing at around 3 per cent a year – Japan is excluded from the assessment because of the tsunami-related disruption. Some are seen as going a bit slower than the others, and the UK, along with Germany and France, is expected to slow down in the months ahead. You can make of that what you will, though the general perception seems to be that this strengthens the case for a rise in eurozone rates.
The core message of the OECD is that things look better than they did last November, as the private sector was coming in to support economic growth. And this is throughout the developed world. From an economic perspective, we are indeed all in this together, which is a bit of a relief.