Interest Rates: Why the Era of Cheap Money Is Finally Ending


Although it was expected that the Bank of England would slightly raise its official rate on November 4, it chose to keep at the historic low of 0.1%. The bank made it clear, and the recent increases mortgage rates, that a rise is imminent. Why is it important to wait?

The Bank of England is acutely aware of the difficulties higher rates can cause for borrowers, and in particular for the largest borrower in the country: the UK government. Given the current level in national debt of GBP 2trn (USD 2.69trn), any rate increase by just one percentage point will cause the government to pay more interest on its bonds for a longer period by GBP 20billion per year.

Also, higher rates can have a dampening impact on property prices and financial assets like shares. This is how monetary policy works. If people feel less rich, they tend to spend less, which reduces inflation pressure.

However, savers can benefit from what is bad for borrowers. Bank deposits will be more rewarded as interest rates rise and so should the finances of our pension funds, which are in dire straits, become healthier.

Inflation is rising regardless of who wins or loses due to higher interest rates. Inflation is on the rise and the bank doesn’t want to lose its credibility.

The inflation dilemma

The UK’s inflation rate has risen for 12 months and is now 3.1%. The bank believes it could rise to 5% next year, which would be much higher than its target of 2%. The bank believes that higher inflation is temporary and will drop as excess goods demand from COVID subsides and supply issues are resolved. However, prices for energy are expected to rise, partly due to climate initiatives. Wage increases will also be a factor in driving up prices if there is a shortage of workers.

Bottom line: nobody knows where inflation is headed, so the bank faces the familiar dilemma of raising rates to prevent future inflation or keeping rates low to preserve the economic recovery and hoping that inflation will drop by itself. It cannot have both.

Similar problems are also found in other countries. The situation in the United States is similar, with inflation at 5.4%, against a target of 2%. The Federal Reserve insists that current high inflation is temporary and justifies keeping its official interest rates (the Fed funds) close to zero.

The Fed isn’t completely in control. announced it would start “tapering” its quantitative easing programme. In which it creates USD 120bn per month to purchase US government bonds and other assets to support the economy, it will begin “tapering”. It will reduce this monthly by USD 15bn starting in November. The Fed acknowledges that excessively stimulating monetary policy has to end.

The Bank of England in the UK has accumulated 800bn of government loans as a result of QE asset purchases. These QE asset purchases were designed to stimulate the economy, particularly after the outbreak of COVID. The bank will eventually need to start offloading this debt.

The bank faces a much bigger dilemma than the bank rate regarding when and how to proceed. QE will increase yields and raise interest costs, which in turn will directly impact all long-term borrowers.

Both risks and benefits

Arcane Research said that this upgrade, as with any other, carries risks. Taproot is a soft fork upgrade so network participants don’t need to update their software in order to make the change. Taproot will still need to be updated by wallets and other services, so users shouldn’t use it “until the vast economic majority enforces it.”

“Miners activating” Taproot is not enough without users following it. If miners do not update but most users do, miners have the ability to reverse the upgrade and take Taproot funds from minority users.” said the company.

However, as fee benefits are expected, most network participants will accept the upgrade. It’s likely that it will take some time for the benefits to become apparent.

reported that almost all developers agreed that Taproot’s core capabilities will be widely used but not immediately.

Taproot is also more popular because more users are using it. This means that Taproot has a greater impact on privacy and efficiency.

After many years of declining yields, they have actually started to rise (see chart below). Investors believe that tighter monetary policy is needed to reduce inflation. This can be done by raising official rates or reversing QE. This also explains why mortgage rates are rising.

All this confirms that the long-running era of ever-cheaper financing is over. This all confirms that the long-term trend of ever-cheaper finance is over.

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