ITwo years ago, at the end of the health crisis and before Russia’s invasion of Ukraine, the ten or twenty year risk-free rates were negative. Today they are uniformly higher than 2.5%. The ten-year rate gap between France and Germany was close to 30 basis points (0.3 interest rate points). Today it is around 60 points. What happened ? What does it change ? And what consequences should we draw from this?
The first explanation that comes to mind is obviously the increase in interest rates from the summer of 2022. The inflationary shock led central banks to raise their key rates, all the more precipitously as they had long believed that the surge in prices would be transitory. In the euro zone, the rate of the European Central Bank (ECB) went from zero to 4.5% in the space of just over a year. But this increase only concerned the overnight rates and, by contagion, the rates a few months out. It is not by monetary factors, by their nature contingent, that we can explain such a clear rise in ten-year rates.
The explanation could be that the markets anticipate a lasting increase in inflation. However, this is not the case: despite the violence of the 2022 shock, the prospects for price increases for the medium term have only deviated from the ECB’s target to a very limited extent. Neither market expectations nor those of forecasters today deviate substantially from 2%. It cannot be them who justify such a marked increase in long-term rates. In other words, the reason for the increase in long-term rates is to be found in changes in the real economy.
Puff of worry
So what happened? To understand this, economists think in terms of the real equilibrium interest rate. Generally denoted “r*”, this rate is the one which equalizes savings and investment when the economy is at full employment of resources. It is a real rate which does not depend on inflation but on determinants such as growth, demographics and the overall balance between demand and supply of safe assets.
The difficulty is that r* is not directly observable. It can only be approached indirectly, from long-term rates, an assessment of what expected inflation is, and an informed judgment on the state of the economy. But that does not prevent it from playing an important role in the conduct of monetary policy. In the same environment of inflation expectations, the same key rate does not have the same impact depending on whether the real equilibrium rate is zero, negative or, on the contrary, close to 2%.
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