When the Vapors entered the charts in 1980 with the catchy Turning Japanese, interest rates were on their way down from the early Thatcher-era peak of 17%. But with the cost of borrowing remaining in the mid-teens, the song was still many years away from being a description of Britain’s monetary policy. Not so today, when it seems the whole world is trapped in the Japanese post-bubble environment of perpetually low growth and almost free money.
When I bought my first flat in 1989, interest rates were 15%. If I say this to younger colleagues or my children they look at me blankly. It is hardly surprising that they cannot comprehend mortgage rates at that level. When I looked just now on Rightmove for two-bedroom flats in the unexciting bits of South London, they clustered around £600,000. At the interest rate my wife and I stretched ourselves to pay 30 years ago, a 95% mortgage (were they to still exist) would today cost more than £85,000 in interest alone. And we wonder why central banks are struggling to raise rates?
Last week Mario Draghi, President of the ECB, became the latest central banker to run up the white flag in the futile battle to return monetary policy to some semblance of normality. He surrendered on three fronts. First, he admitted that interest rates would remain at their current record low until next year at the earliest. This means he will end his eight-year term in November having never raised interest rates. Not once. Second, he confirmed that the reversal of the bond buying that has supported low interest rates in recent years will not begin until after interest rates have started to rise. Finally, he unveiled another, third round of cheap loans to banks which are prepared to expand their own lending.
You cannot argue with Mr Draghi’s approach. He is simply responding to the data. And there is nothing in the growth or inflation numbers to suggest that he should be tightening policy further. The European Central Bank’s in-house economists recently reduced their forecasts for both of these in each of the next four years. The European economy is consistently and persistently weaker than expected.
It is not alone. All the major central banks are giving up the unequal struggle to return interest rates to pre-crisis levels. The Federal Reserve got further than any other, but not even a tax-cut-fuelled sugar rush last year could get US interest rates above their current range of 2.25-2.5%. Jerome Powell, the Fed chairman, is desperate to take rates higher than this to provide some fire-power for when, inevitably, the economy turns down next year or in 2021. He has seemingly run out of road, however. Janet Yellen, his predecessor, said recently that she thought the next move in interest rates in America would actually be down.
It is not hard to see why. The collapse in China’s exports and imports, announced on Friday, underscored the damage caused to global trade by President Trump’s reckless trade war. Even before the numbers were unveiled, the seriousness of the situation had been made clear by the unusually candid assessment of the headwinds facing China by premier Li Keqiang at the National People’s Congress. The dramatic slowdown in earnings growth in fourth quarter earnings on Wall Street showed that it is not just China feeling the pressure. There are no winners in a trade war.
As for our own stalled monetary normalisation, the Bank of England is powerless to raise rates in the face of what could be years of uncertainty over Britain’s relationship with Europe. What no-one is saying as we obsess about the withdrawal process is that, even if the Prime Minister’s agreement is miraculously approved this week, the real talks have not even begun. The Brexit uncertainty that has left business leaders pulling their hair out in frustration could be affecting investment decisions for years to come.
Although central banks would like to create some leeway to stimulate their economies come the next recession, they are not wholly disappointed that they can’t raise rates. As an indebted individual, there are only two ways you can deal with excessive debts - pay them off or refuse to do so (default). A sovereign borrower, however, has a third option. It can let the real value of its debts fall over time thanks to inflation. With real wages rising and house prices stagnating, the apparently painless unwinding of the developed world’s debt mountain is underway.
All of which means that interest rates are going to stay lower for a lot longer than anyone predicted 10 years ago when they were slashed in the wake of the financial crisis. If you have not adjusted your investments to reflect this fact, then you have probably not been paying attention - but better late than never.
There are three things to focus on in this environment: quality, income and price. In a low-growth world with tepid demand and little ability to raise prices, only the strongest businesses will survive, let alone thrive. Companies with defendable ‘moats’ and pricing power will reward investors.
In a lower-for-longer interest-rate environment, high and sustainable income will also be at a premium. There are plenty of high dividend yields in the market today - making sure they are really going to be paid into the future is essential. As for price, a low growth, low interest rate environment argues for a sideways moving market. Timing the tops and bottoms of the market cycle may be impossible but focusing your attention on the cheapest markets at any one time and avoiding the priciest ones will repay the time and effort. This type of active investing is not easy but, if we are really turning Japanese we will have plenty of time to practice.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.