Interest rate to drop once inflation is tamed- IMF  

Oluwanifemi Ojo
Oluwanifemi Ojo
International Monetary Fund

The International Monetary Fund has stated that the rise in borrowing costs is expected to be temporary as long as high inflation is brought under control.

IMF estimated that interest rates in major economies will likely decrease to the levels seen before the Covid-19 pandemic due to the presence of an ageing population and low productivity.

Meanwhile, monetary policy has been tightened in response to rising inflation, which has caused a sharp increase in real interest rates.

Policymakers are now facing the important question of whether this increase is temporary or partly due to structural factors.

Interest rates in the UK have been increasing since December 2021, going up from 0.1% to 4.25%.

Central banks around the world, including in the UK, the US, and Europe, have been increasing interest rates to combat inflation, which refers to the rate of price increases.

In the UK, inflation is currently at its highest level in almost 40 years, which is being caused by various factors such as higher energy prices and surging food costs. One of the reasons for the increase in energy costs is the invasion of Ukraine by Russia.

As a result, many homeowners are facing higher mortgage payments.

The IMF said in a blog post on its website that the hike in real interest rates ” are likely to be temporary”.

It further stated, “When inflation is brought back under control, advanced economies’ central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels.”

Speaking to BBC on Tuesday about the reason the older people will affect inflation, the fund manager at Polar Capital, George Godber, said that they tend to spend less.

In his words, “The amount that you spend relative to your income is highest when you’re in your 20s, 30s and 40s – often that’s maybe young families, when you’ve got households forming, you’ve got couples coming together, they tend to spend the most when they decorate and buy a car or whatever, and you as you get older in life you slow down your consumption.

“There’s less heading to Glastonbury and nights out on the town, there’s more sitting at home and watching the Antiques Roadshow, so therefore your spending patterns sort of reduce and you save more and so an ageing population tends to be disinflationary.”

The governor of the Bank of England, Andrew Bailey, has stated that the proportion of adults aged 20-59 years in the UK has decreased to less than 65% over the past decade and is expected to decline further. This is attributed to lower birth rates and increased life expectancy.

In addition to the aging population, IMF also said that low productivity will cause interest rate increase to be temporary. Productivity is “the measure of how many goods and services are produced – would bring inflation down.

In a speech given last month, Mr Bailey acknowledged that before the 2008 financial crisis, UK productivity had benefited from the manufacturing sector.

He explained, “But following the financial crisis, manufacturing productivity growth fell back sharply. This fall in manufacturing productivity is the main cause of the slowdown.”

Prior to the Covid pandemic, the interest rate in the UK was at 0.75%. However, it was cut twice in March 2020, bringing it down to 0.1% as the country went into lockdown.

Inflation has been steadily rising over the past couple of years and in February, it reached 10.4%, more than five times higher than the Bank of England’s 2% target.

After the Bank of England’s decision to increase interest rates again in March, it was stated that they expected inflation “to fall sharply over the rest of the year.”

This is due to the government’s ongoing support through the Energy Price Guarantee scheme, as well as the decrease in wholesale gas prices.

When asked if he believed that interest rates had reached their peak, Mr Bailey did not provide a clear answer.

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