People have got so used to ultra-low interest rates amid talk of stagnation and deflation that they can barely imagine anything else. But an interesting talk last week by Charles Dumas of Lombard Street Research suggests that the West is in solid shape, rate rises may be closer than we think, and the 35-year bond bull market is over.
The speech concentrated on the eurozone economy, which Dumas says is in better shape than most analysts realise. The German economy is 7% above its pre-crisis peak; Spain is growing at more than 3%. The euro’s inflation-adjusted exchange rate is over 10% lower than during the eurozone crisis, making European products very competitive on world markets. The collapse in the oil price in 2014 was an “extraordinary stroke of luck” that fuelled “impressive” household spending and also lowered inflation, prompting the European Central Bank to keep printing money. Solid trade and consumption has underpinned strong capital spending.
The three “main engines of economic advance”, then, are in “pretty good form”. Meanwhile, the financial and eurozone crisis reduced the economy’s productive capacity, and hence the potential, or trend, growth rate. So the rate at which the eurozone can expand without stimulating inflation – economy-wide demand exceeding supply, essentially – is lower.
Dumas thinks the eurozone is already growing at trend. As the oil slide falls out of the annual inflation calculation, the headline rate will head back to 1% in the next few months. That will gradually prompt the realisation that money printing needs to stop: deflation, after all, has been averted and the economy will be strengthening beyond trend soon.
Dumas thinks we can expect quantitative easing to start tapering off next summer. With America also growing at above trend, we will see bond yields, which may already have seen the low post-Brexit, climbing in anticipation of dearer money, thus definitively turning their back on a 35-year fall.