European savers hoping to see higher rates must be wary of a new foe after Mario Draghi – demography.
The rapid aging in many of the euro area’s largest countries means that rates will probably remain low even when the European Central Bank’s puts an end to the current cycle of extraordinary accommodation. In fact, nominal short-term rates could be as low as 1 percent in 2025, if the population evolves in line with current projections.
The conclusion comes from a study by economists Giuseppe Ferrero and Stefano Neri of Bank of Italy, and Marco Gross of the European Central Bank.
The ageing of society affects monetary policy in several ways. Higher longevity and lower birth rates mean that there are fewer workers to fund pensions, requiring retirees to save more; this in turn can dampen investment and spending. Also, the simple fact that the labor pool is shrinking implies that less capital will be invested to put people to work.
“The high persistence of demographic factors makes them particularly relevant from a monetary policy and financial stability perspective, to the extent that they affect medium-term trends in nominal and real interest rates,” write the authors. “Over the next decade, adverse demographic developments in the euro area may continue exerting downward pressure on short- and long-term nominal and real interest rates, potentially limiting the ability of monetary policy to adjust its stance.”
The study examines three scenarios for the evolution of the euro-area society in terms of migration, fertility, population growth, dependency ratio and so on: the one outlined by the European Commission in its 2015 Aging Report; a more optimistic baseline where things remain as they are today; and one which is halfway between the two.
In the Commission scenario, potential growth in 2025 stands at only 0.6 percent per year, the GDP deflator – a measure of domestically-generated inflation – is at 1 percent, unemployment is higher than it is today at almost 10 percent while real rates and productivity are stuck near zero.
This means nominal short rates, largely set by the ECB, would be around 1 percent by then, compared with a pre-crisis average of over 3 percent.
This is still far off now – the main refinancing rate is at zero and the ECB says it won’t rise until well after the end of its asset purchases, or in late 2018 at the earliest – the long term trend is clear. Meanwhile, European savers could maybe take a more lenient look toward immigration if they want more solid returns in the decades ahead.