by Yoruk Bahceli

(Reuters) – Borrowers looking for a quick and sharp cut in central bank interest rates may be disappointed as financial markets expect borrowing costs to be high in the coming years.

Whatever the extent of the fall in the cost of credit in 2024, the rates priced by money markets show that the decade of near-zero interest rates that followed the great financial crisis of 2008 is unlikely to end. reproduce as long as inflationary pressures and public spending remain high.

Such a scenario could accentuate the difficulties of many public and private borrowers, whose borrowing costs do not yet fully reflect the record rate increases decided by central banks over the last two years.

Money markets predict that the US Federal Reserve (Fed) will reduce the federal funds rate to around 3.75% by the end of the year, but it will only drop to around 3% at the end of 2026, before rising to around 3.5% thereafter, far from the almost zero rates observed before March 2022.

As for the European Central Bank (ECB), its deposit rate, currently at 4.0%, should settle at only around 2% by the end of 2026, whereas it was negative between 2014 and July 2022.

“This is simply a normalization of (central bank) policy. It is not a return to accommodative monetary policy,” explains Mike Riddell, portfolio manager at Allianz Global Investors.

According to economists, financial market expectations reflect the scenario of a shift towards so-called “neutral” interest rates, that is to say which neither stimulate nor slow down the economy.

The current situation of the US economy, which has so far escaped a recession that many predicted due to the Fed’s aggressive tightening, also supports this argument.

The threat of a resurgence of inflation against a backdrop of geopolitical tensions, a more accommodating budgetary policy and productivity gains thanks to artificial intelligence, are all factors likely to favor an anchor towards the neutral rate, also called ” R-star.”

WHERE IS THE NEUTRAL RATE LOCATED?

The neutral rate, impossible to determine in real time, is the subject of numerous debates and not everyone is convinced that it has moved, even though its fixation is essential to understand the growth potential of an economy and a central bank’s decision on how much to cut rates in the future.

Financial markets’ expectations in this area are currently higher than the Fed’s estimate of 2.5%, even if several bank officials have mentioned a rate of more than 3%.

In the euro zone, ECB officials are talking about a neutral rate of around 1.5% to 2%.

“I’m skeptical that the R-star will move,” said Idanna Appio, a former Fed economist who is now a portfolio manager at First Eagle Investment Management.

Idanna Appio says she does not understand why markets are counting on continued high rates, when many measures of inflation forecasts suggest a return to central bank targets. It is premature to talk about an increase in productivity, she added.

Even if a projection on the evolution of rates is not an easy exercise and the markets can be wrong, caution is necessary for borrowers, accustomed in recent years to low rates.

“This means that companies will have to refinance at rates that are reasonably, if not considerably, higher than those they have experienced over the past five years,” notes Patrick Saner, head of macroeconomic strategy at Swiss Re.

“In this context, the higher rate environment is actually very important, especially when it comes to planning for businesses,” he added.

(Reporting by Yoruk Bahceli; by Claude Chendjou, editing by Kate Entringer)

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