No return to cheap money
The days of ultra-low interest rates, which became the norm between 2009 and 2021, are over.
Interest rates reached the highest levels in over 15 years in the US and Europe in 2023 as central banks sought to squeeze inflation out of the system. The peak in rates was short-lived. The European Central Bank made its first rate cut in May of last year, followed by the Bank of England in July and the US Federal Reserve in August. US rates now stand 100bp below their peak; euro area and UK rates have dropped by 75bp.
Financial markets think rates are unlikely to fall dramatically from here. The scope for rate cuts seems most limited in the US where the economy is running hot and expectations for growth and inflation are climbing. The Fed has made clear that it is in no hurry to reduce rates and financial markets are pricing in only one full 25bp rate cut this year, taking US rates to the 4.0% mark by December.
The outlook for UK activity has deteriorated since the summer and, earlier this month, the Bank of England halved its forecast for GDP growth in 2025 to 0.75%. Activity in the second half of last year was almost flat, yet inflation rose from a low of 1.7% in September to 3.0% in January, partly on higher energy and food costs. Inflation is likely to edge higher still over the summer to around 3.5% before falling back. Markets think that the Bank of England will be prepared to “look beyond” the current uptick in inflation and expect rates to be cut by 25bp in May and again in autumn, taking the base rate to 4.0% by the end of this year.
The outlook for growth in the euro area has also deteriorated and at a faster rate than in the UK. With inflation looking more constrained than in the US or the UK, markets are pricing in three 25bp rate cuts by the European Central Bank this year, taking rates to around the 2.0% mark, half the expected rate in the US or the UK.
Whatever the precise timing of changes in rates, what I find most striking is the markets’ assumption that the days of sub-1.0% interest rates, which became the norm between 2009 and 2021, are over. Markets believe that in the long term, rates will run at around the 4.0% mark in the US and the UK and at about 2.3% in the euro area – rates that are close to those priced in for the end of this year. On this view governments, consumers and corporates are going to have to get used to far higher funding costs than in the 2010s.
A personal view from Ian Stewart, Deloitte's Chief Economist in the UK. To subscribe and/or view previous editions just google 'Deloitte Monday Briefing'.