Governments could incur a 20 percent increase in what they pay to service debts if central banks boost interest rates back to 2007 levels, according to a study by McKinsey & Co.
Seeking to assess the winners and losers from the recent era of low rates and quantitative easing, the consultancy’s research division estimated governments in the U.S., U.K. and euro area benefited by $1.6 trillion from central bank policy in recent years. That could be thrown into reverse when monetary support is withdrawn, with the U.S. government facing $75 billion extra annually in debt-interest payments if the Federal Reserve restores pre-crisis policy, it said.
“Understanding at a micro level how unconventional monetary policies impact different players in the economy sheds light on the risks ahead,” said Richard Dobbs, director of the McKinsey Global Institute in London.
The study comes as global central banks pledge to keep interest rates low until recovery is assured. The Fed is signaling it won’t raise rates even if it begins tapering its monthly asset purchases, while the European Central Bank last week cut its benchmark to a record low 0.25 percent. The Bank of Japan is chasing a 2 percent inflation target and the Bank of England repeated yesterday it won’t consider lifting rates until unemployment falls to 7 percent.
Governments have benefited from low rates and the injection of almost $5 trillion of liquidity since the financial crisis broke out in 2007, McKinsey said. The gains amounted to just over $1 trillion for the U.S., $365 billion for the euro area and $170 billion for the U.K., due to cheaper debt costs and the handover of profits on asset purchases from central banks to state coffers.
Non-financial companies in the three regions also have made out, to the tune of $710 billion, as their borrowing costs fell, according to the report. That though hasn’t led to an increase in capital spending, as company executives have viewed the lower interest rates as temporary, Dobbs said.
Households lost $630 billion in net interest income, with older people holding interest-bearing assets suffering the most, according to the report.
European banks lost interest income of $230 billion, while U.S. rivals experienced a $150 billion increase as the interest paid on deposits declined more than that received on loans. With bonds the asset of choice for central banks to buy, the value of sovereign and corporate bonds in the U.S., U.K. and 17-nation euro area jumped $16 trillion between 2007 and 2012, McKinsey said.
As interest rates rise, companies will need to use capital more efficiently and bond investors could face write-offs on the value of their holdings, the report shows.
McKinsey found little evidence that low interest rates boosted equities. While share prices did react in the short run to announcements of central bank moves, there was no lasting impact as investors refocused on trends in corporate profits, according to Dobbs.