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  • Writer's pictureInvestment Synergy Team

Interest rates are rising this week – should we expect a bumpy road ahead?

At the moment, interest rates are almost absurdly low, and I believe the present crop of central bankers will be judged harshly by history, writes Hamish McRae

This will be the week of rising interest rates from the world’s central banks. The most important increase will come on Wednesday from the US Federal Reserve, and the main question there is whether it will be a half point rise or a three-quarter point increase.

On Thursday, the Bank of England is widely expected to increase its rates by a quarter per cent to 1 per cent, which would be the highest since 2009. Other central banks where increases are on the cards include Australia, the Czech Republic, Poland, Iceland and maybe Norway.

This is a global thing. The financial markets expect several more increases this year and next, with the debate really being about the speed at which rates are likely to climb and the levels they will reach.

This has led to obvious concerns. Might rates rise so fast as to push major economies into recession this summer? Several countries, including the US, have had negative growth – economist-speak for an economy shrinking – in the first quarter. Another quarter of shrinkage and that would be the technical definition of recession.

Another question is whether it is this prospect that has depressed US shares so much this year. Or is it more because the share price of the tech giants had become overinflated? We cannot know the answer, but we certainly know that the share price of nearly all those giants has been very weak. Amazon shares plunged on Friday, and are now down 27 per cent on the year to date. Shares in Meta Platforms, the new name for Facebook, are down more than 40 per cent. Even Apple, which is doing very well as a business, is down more than 13 per cent.

So it would be unrealistic to pretend that there will be no disruption ahead. However, we do have the experience of that period to guide policy, and that should help the policymakers to do better this time.

At the moment, interest rates are almost absurdly low, and I believe that the present crop of central bankers will be judged harshly by history. But they have begun to do the right thing, and while we should expect a bumpy couple of years with some rise in unemployment, I can’t see unemployment in anything like the double digits it hit in the 1980s. UK unemployment was more than 10 per cent from 1981 to 1987, and again in 1992 to 1993. We are in better shape now, with UK unemployment at 3.8 per cent, the lowest since 1974.

Asset prices? I don’t think there is much that economists can say about share prices over the next few years, except to observe that over a very long period, equities have given a total return over and above inflation of 5 per cent to 6 per cent.

Still, another hugely important effect will be what happens to property prices around the world. US homes are still rising and are up an astounding 19 per cent on the year. That makes the increase here in the UK, 12.1 per cent according to Nationwide, seem almost modest by comparison. Much the same is happening across Germany, indeed across the entire developed world. Again, this is a global thing.

But I think the question in all of our minds is not so much what will happen this week or in the coming months, but rather what is likely to happen to interest rates, inflation, house prices and so on in the next few years. Things change so fast. A little over a year ago, central banks were not at all worried. For example, the Bank of England thought that inflation would be around 2 per cent this year and next. Now they are on red alert. But maybe in another year’s time, the panic will be over – or, perish the thought, they will be even more frightened as inflation threatens to go completely out of control.

So what on this somewhat longer view can we sensibly expect? My starting point is that there are no votes in favour of high inflation. People hate it, and are frightened by it. So the political pressure will be on governments to see that it is brought down, and therefore it will be brought down. If the present batch of central bankers fail in this task, others will be hired to do the job – just as Paul Volcker was tasked with this when he became chair of the Federal Reserve in 1979.

But curbing inflation requires damping down the economy, cutting out the easy speculative gains that people are able to make when the money taps are on. The previous main experience that we have of this process in the early 1980s and 1990s was painful, with high unemployment, high interest rates and two recessions. (Volcker increased the Fed’s main interest rate to 20 per cent.)

As for house prices, there have been several periods in the past 50 years in the UK when they have fallen. The most recent experience was after the banking crisis in 2008, when they came down by 15 per cent. That could happen again. But after such a fall they have, on average, always recovered. The population is rising and people need homes.

That is surely the thing to remember this week. Rates are going up and inflation will be around for some while, but we have to get on with our lives. And, frankly, we should thank our good fortune that we can do so.

Investment Synergy - `The Times They Are a-Changin' (Bob Dylan)

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