Interest rate rises resulting from restrictive monetary policy will shape the global economic and financial markets for years, damaging growth and affecting activity. At the same time, it’s encouraging to see the resilience of the lending market.
Although inflation is far from tamed, most of the central banks' major interest rate rises seem to be behind us. Now markets and investors are looking for the best way forward in this new world of tighter monetary policy.
There were some seismic shifts in the investment landscape, with bonds and cash suddenly being attractively yielding investment alternatives, while large debt piles and near-term refinancing needs have turned from commonplace to serious problem in a matter of a few quarters.
Markets seem to be swinging back and forth between hope and fear of the opportunities and dangers of this new environment
So far, markets seem to be swinging back and forth between hope and fear of the opportunities and dangers posed by this new economic environment. But beneath the noise and exuberance of market swings, restrictive monetary policy will have a long-lasting impact on growth and inflation that will shape the global economy and financial markets for years to come.
Central banks are required to ensure price stability by tightening monetary policy. They do this by raising refinancing rates for corporate banks, which in turn impacts the economic behavior of financial and public institutions, as well as corporations and consumers.
The past 15 months saw one of the steepest monetary tightening cycles in four decades, with virtually every major central bank hiking interest rates (or at least, allowing yields to rise). But while lending conditions have tightened considerably from ultra-easy levels since late 2021 in the US and early 2022 in the eurozone, the lending market seems to be functioning well. Corporate refinancing is not necessarily much more difficult now, although it has become much more expensive and will continue to be so.
The past few quarters have reminded us that the impact of monetary policy on growth comes with a considerable time lag. Recent growth rates have been low, but positive, and the record monetary tightening has not slowed economic activity too much yet. Unfortunately, the damage to growth is likely just delayed, not avoided altogether.
Interest rates – and financing costs – have risen sharply over time, weighted by GDP for the world's most important economies. The financing cost increase has been the sharpest since the oil crises of the 1970s. Despite the brutal rise in rates, it's encouraging that the overall lending process has not been disrupted. This gives us hope that the global financial system can withstand the rates tsunami – in spite of the occasional meltdown of smaller banks that failed to manage their asset-liability mix. Still, it would be foolish to expect that exploding funding costs will not impact the consumption and investment plans of companies and individuals, and thus growth.
While lending conditions have tightened quite a bit, according to bank lending surveys, it seems that the ease of arranging lending has been largely unaffected. Standards have become tighter but are not yet disruptive. However, a look at the effective cost of bank financing reveals that capital costs have skyrocketed, raising the profitability hurdle for companies and projects, and jeopardizing consumer spending that relies on external funding.
In summary, we think that the damage to growth from the recent dramatic interest rate rises will turn out to be a slow-burning drag on activity over time rather than a fast recessionary flashfire, and we expect virtually flat global growth rates for the rest of 2023.