How super-low interest rates are ruining the economy

Super-low interest rates are not helping Britain’s economy recover, says Merryn Somerset Webb. They’re holding it back.


Central bankers may not like low interest rates, but they don't want to be the one to burst the bubble

Regular readers will know that this is the time of year when I get back from holiday and head for the Edinburgh Festival. There I sit through a large number of shows, some good, some utterly awful, and wait for somebody on some stage or the other to say something interesting I can tell you about.

This year I got lucky. I didn't have to wait long at all. The first show on my list was a collaborative theatre project by Theatre Uncut. It contained various rants against capitalism, austerity, bankers and the bank bailouts of the financial crisis (all standard festival themes since 2009).

One of the actresses pointed out that the public went along with the bailouts and quantitative easing for one simple reason: they were told that "something worse, not better, would happen if they didn't".

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And they knew too little of global finance even to begin to argue with that. Today, something similar is happening with interest rates. In the UK, the bank rate has now been 0.5% since 2009.

And it looks like it will stay there for a good while longer. The argument for keeping rates at their lowest level for at least 300 years (it's probably a lot longer than that, but the data before that is a bit iffy) is a simple one: if they are raised before we are sure that the economy is growing at a reasonable clip, it could all go horribly wrong something worse, not better, will happen.

But here's the problem: we may be looking at it all the wrong way around. What if the malign effects of super-low rates are so extreme that they are holding back the economy from recovery? What if low rates are more the problem than the solution?

Let's look at some of these effects. There is the issue of capital misallocation. Low interest rates encourage people to borrow money to invest in things that aren't necessarily good investments global corporate debt has more than doubled from 26% to 56% of GDP according to McKinsey.

All this borrowing can be deflationary in that it creates excess supply (the US oil boom and the consequent collapse in the price of oil being a case in point). Given that super-low interest rates are supposed to be causing inflation, that's something of a problem. All this borrowing also pushes equity markets higher than seems good the biggest buyers of shares in the US market have been not real investors but companies buying back their own shares with cheap borrowed debt.

The result is that not only do "equity valuations appear high at a time when the outlook for earnings growth is poor", as Troy's Sebastian Lyon puts it, but in building up debt that will eventually have to be paid back and not spending it on useful research and development or capital expenditure "companies have created an uncertain outlook for their own long term profitability". That seems a shame.

Loose monetary policy has a nasty effect on other asset prices too. It explains why house prices in the UK are so stubbornly high, and why the number of houses for sale in the UK is at a record low. If you can't get a return on cash, says Capital Economics, you might as well rent out your old home or just keep it empty when you move. Low interest rates are a key factor here.

The next thing to look at in the UK at least is the wicked effect that very low rates have on companies with final salary pension schemes. I know I have mentioned this before and I know it is almost intolerably boring, but it is very, very important. The lower interest rates go, the larger a capital sum is required to meet the obligations of a pension fund, and the more cash companies have to pour in to the funds to keep them technically solvent. That's cash that then can't be used for useful capital investment or expansion.

And it is a lot of cash. According to Hymans Roberts, UK companies have paid some £500bn into their private pension schemes over the past 15 years, but their total deficit has still risen from £250bn to about £900bn. Do you think that might go some way to explaining the UK's low growth and even its productivity problem? I do. I could fill many more pages with the nasty effects of very low interest rates, but I'll just chuck in one more to make the point that there are almost endless micro effects.

You will know that the National Health Service is a little strapped for cash. You might also know that paying out on medical negligence cases costs it a fortune (£4.5bn over the past five years). What you might not know is that these payments rise as interest rates fall. The NHS is obliged to pay out lump sums that will provide set incomes for the lifetime of the patient. And just as is the case with pension funds, the lower rates are, the higher the sums required to create the income are increasing the amounts that the all-but-bankrupt NHS has to pay out.

Finally, it is worth noting that very low rates don't exactly encourage the one group in the UK with piles of cash to spend it. If you are a pensioner looking at an interest rate of 0.25%, on your money, you won't much feel like splashing out on anything you don't really need whatever your house is worth.

My point here is a simple one: central bankers are looking for reasons to raise rates that involve good news ("the economy is strong enough to take it"), but they might be looking at it the wrong way around. They should instead focus on the reasons to raise rates that involve bad news ("we're screwing up the economy with this low-rate stuff we'd better try and get 'em up").

I suspect that most central bankers have sympathy with this view they know, as comedian Daniel Kitson pointed out in my second festival show on Thursday that the future is not the mystery many think. It is instead the "slowly accruing consequences of the present".

And they know that the slowly accruing consequences of super-low rates are pretty nasty. It's just that none of them want to go down in history as the guy who popped the great asset price bubble of the 2010s. Who would?

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.