FOR much of late 2008 and early 2009, world interest rates were being slashed to unprecedentedly low levels, in an attempt to relieve the burden of debts taken on by over-optimistic borrowers in the good times.
These were, in some cases, proving too much to service once a slowdown arrived and the price of assets used to back the loans (especially housing and commercial property) began to tumble. The resulting crunch threatened the security of the banking system, leading to the concerted global programme of monetary and fiscal policy easing that reached a crescendo in early 2009.
As the evidence accumulates that this policy response has worked, with even the developed world coming out of recession, interest rate expectations – and, in some cases, official rates themselves – have started to rise. The difference is that, while the cuts took place in concert, the rises are so far confined to a series of solo performances from central banks whose economies were less affected by the downturn. Australia and Norway led the way in 2009, with the early days of 2010 seeing China steer short term rates higher. This comes against a backdrop of its economy responding so vigorously to last year’s fiscal stimulus that it overtook the US in 2009 for new vehicle registrations. China’s economy is forecast to grow at almost 10% in 2010.
The question is whether investors should celebrate this turning point or worry about it.
Normally, rising interest rates signal an intention by central banks to counteract a rise in inflation. This often occurs after a period of solid economic growth that has used up spare capacity, with a rising cost of borrowing intended to cool activity down. Although the pace of growth in China poses risks of overheating, this description could hardly be used about the world's developed economies, where growth rates remain below historic norms and have made few in-roads into the fall in output during the recent recession.
Although, so far, interest rate rises have been confined to a few countries where growth has held up well, they have prompted debate on the timing of rises elsewhere. Whereas low interest rates allowed equity markets to rally in 2009 despite poor corporate reports, the opposite risks apply in 2010 – corporate profits are improving significantly but investors will temper this with the risk of rising interest rates. Even if rises are an adjustment from abnormally low levels, a near-term rise in inflation (owing to oil prices and VAT being higher than a year ago) means that there is a risk of over-zealous central banks tightening unnecessarily, or that investors will fear this outcome. Although central banks in developed economies seem keen to emphasise that rates will be kept low (because spare capacity should keep inflation in check) the transition from an interest-rate driven market rally in 2009 to one underpinned by corporate profits growth in 2010 could have some wobbly moments. However, when rates do rise, it would mark confirmation that the recovery is properly established – a cause for celebration rather than hand-wringing.
David Owen,
Senior Investment Director,
Rensburg Sheppards
