But he adds: “While these changes may mean inflation in future overshoots central bank targets regularly, rather than undershooting them as was the case in the past, I think the overshooting may be in the range of 2.5 to 3 per cent, rather than anything more dramatic.”
Saleheen echoes this: “We expect policy rates to settle at a higher level compared with after the [global financial crisis] and during the Covid-19 pandemic. Vanguard research has found that the equilibrium level of the real interest rate [also known as r-star or r*] has increased, driven primarily by demographics, long-term productivity growth and higher structural fiscal deficits.
“This higher interest rate environment will last not months, but years. It is a structural shift that will endure beyond the next business cycle and, in our view, is the single most important financial development since the GFC,” she adds.
The equilibrium, or real rate of interest, is the level rates can reach in an economy without being so low as to prove stimulative or too high as to be contractionary.
The level of this rate is impacted by the prevailing inflationary pressures in the economy. Generally speaking, if underlying, long-term inflationary conditions rise, then there is less scope to cut rates to stimulate economic growth, and as such a rate cut would be inflationary.
David Thorpe is investment editor at FT Adviser
