The major central banks are in a dilemma. They have used up most of their ammunition to try to revive dormant economies and ward off deflation. The intention had been for the United States Federal Reserve Board to make the first tentative steps in unwinding this stimulus next month, by starting to push up interest rates. But recent market turmoil, and mixed signals from the US economy, are giving it pause for thought.
In today’s interconnected financial world, this is not just a US issue. The Bank of England had been expected to follow the lead from Washington. European interest rates were set to remain low for some time yet, but the European Central Bank (ECB) had signalled that its policy of quantitative easing would probably draw to a close in September. Now all is up in the air.
The interest rate dilemma has wider ramifications. It has the potential to put more pressure on some emerging economies, many of them already facing difficulties because of falling commodity prices and slowing growth in China. It also adds to a general mood of uncertainty internationally about growth rates for the developed economies as they emerge from the crisis years. Nor do most governments have the scope to spend more to stimulate growth.
The persistence of low growth and inflation is likely to keep interest rates lower, for longer. The problem for central banks is that if they wait for signs of inflation to reappear, it will likely be too late. However, the cost of a persistent period of very low growth and inflation are high, too.
For the moment, barring strong US figures in the next few weeks, the Federal Reserve Board is likely to hold its fire. In turn this will leave the Bank of England in a dilemma. And after its monthly meeting last week, ECB president Mario Draghi hinted that its quantitative easing programme could be continued beyond next September. The ECB was late to the party and it is no coincidence that the euro zone economy is weaker than the US and UK.
It all has mixed implications for Ireland. We need a continued revival of international growth for our exporters – at least to a moderate level. However, continued low interest rates are also to our advantage. The exchequer saved almost €400 million so far this year on the expected cost of servicing the national debt, due to the rock bottom rates on government bonds.
Meanwhile, low interest rates help indebted households and businesses.
Interest rates will rise at some stage, however. It all argues for making as much progress as possible in relation to the public finances in the next couple of years. Rising interest rates will make progress more difficult.
We have a once-off opportunity to right our finances which should not be missed.