Why a higher-rate era may not pain economies and individuals

WASHINGTON (AP) — Consumers, businesses and investors are facing an era of higher borrowing costs as some of the lowest global interest rates in modern history begin to rise.

Yet the message from most economists is a reassuring one: Rates won’t likely climb fast or high enough to inflict much damage on economic recoveries in the United States or Europe. Borrowers and investors may feel some short-term pain but should manage fine in the long run.

Part of the reason for the optimism is that rising rates themselves are a healthy sign: They mean that U.S. and European economies are strengthening, people are spending, companies are hiring and prices are starting to rise at more normal rates. The risk of too-low inflation — which typically slows spending and makes loan repayments costlier — has receded.

“There is an economic normalization taking place around the world,” says Eric Lascelles, chief economist at RBC Global Asset Management.

For people who depend on interest income from savings accounts or certificates of deposit, higher rates offer at least a little relief from the punishingly low rates of recent years. Businesses and consumers will face modestly higher loan payments.

At their policy meeting this week, Federal Reserve policymakers are sure to discuss their timetable for raising short-term rates from record lows, where they’ve been since 2008. Most analysts foresee the first hike in September, with additional increases occurring very gradually.

Even when the Fed raises short-term rates, longer-term rates — which more directly affect individuals and businesses — won’t necessarily follow in lockstep. Longer-term rates are determined by investors. As long as inflation appears under control, economies seem sturdier and investments generally safe, long-term rates should remain low by historical standards.

Even if Greece defaulted on its loans and rattled European markets, many nervous investors would shift money into the safety of U.S. Treasurys, which would drive U.S. yields back down.

For now, though, rates are climbing in financial markets. Since mid-April, the yields on 10-year U.S. Treasurys have gone from 1.85 percent to 2.36 percent. Yields on 10-year German bonds surged 10-fold, from essentially zero (0.075 percent) to nearly 0.83 percent. Yields on Spanish 10-year bonds have gone from 1.45 per cent to over 2.40 percent.

In recent years, rates have risen for one reason for another, only to retreat again. Economists, confounded by the persistence of super-low rates, cautiously predict that rates are headed up for real this time — though they don’t see rates rising in a straight line.

“We’re all a bit wary about making bold statements,” Lascelles says.

Why should this time be any different? In the developed world, economies appear more durable.

The 19 economies that use the euro currency are expected to grow a collective 1.5 percent this year, up from 0.9 percent in 2014. They’ve been helped by a big drop in oil prices and in the value of the euro — a trend that helps European exporters by making their goods more affordable overseas.

Early this year, investors had grown fearful that Europe faced a growth-killing deflationary spiral in which consumers and businesses might delay spending in anticipation of lower prices later. As Europe’s prospects have improved, those fears have eased.

“We have turned the corner,” says Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics. “There is a degree of normalcy returning to the financial system of Europe.”

Japan’s economy will grow 1 percent this year after shrinking 0.1 percent last year, the International Monetary Fund forecasts.

In the United Sates, after icy weather and a West Coast labor dispute killed growth from January through March, the economy is expected to expand 2.5 percent in 2015, the IMF predicts.

That isn’t much better than the 2.4 percent growth last year. But the U.S. job market is humming. Employers have added nearly 3.1 million in the past 12 months — a pace not seen since the boom years of 1998-to-mid-2000. U.S. unemployment was 5.5 percent in May, compared with 6.3 percent a year earlier.

That said, rising rates are starting to affect consumers. In the United States, the average rate on 30-year fixed mortgage last week reached its highest level (4.04 percent) since November. Homeowners with adjustable rate mortgages should probably try to lock in a fixed-rate mortgages before rates go much higher.

“Adjustable rate mortgages are at the lowest level they can be,” says Greg McBride, chief financial analyst at Bankrate.com. “Those rates will only go up.”

He adds: “If you have credit-card debt, grab one of those zero rate or other promotional offers now so you can accelerate the repayment of your balance. Once rates start to rise, those zero-rate offers will become fewer and far between.”

Investors, who have grown used to cheap money, may lose confidence in a new era of rising rates. But McBride and other analysts don’t see rates rising dramatically unless the economy were to suddenly surge and ignite inflation. For now, inflation is running well below the 2 percent level that the Fed and the European Central Bank like to see.

“Yields are going to rise,” says Megan Greene, chief economist at John Hancock Financial Services. “But they’re going to rise more slowly than everybody expects.”

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