Be the latest country to review its official interest rates

By David McEwen

Tuesday 13th September 2011

On Thursday, New Zealand will be the latest country to review its official interest rates and, like the US, UK and others, will almost certainly not raise them.

This country is due for a rates raise, not least because we have lagged Australia which has made several moves in the past couple of years and the rates were trimmed here to help out with the aftermath of the Christchurch earthquake.

On the other hand, higher rates will attract more investment here and push up our already painfully high exchange rate, which the Reserve Bank and exporters most certainly will not want to see.

Meanwhile, interest rates in the USA have fallen to record lows with 10-year treasury stock trading for around 1.92%, having been as low as 1.87% on Monday. In Europe, the yield on the 10-year German government bond fell yesterday to 1.78%, having likewise visited an all-time low of 1.71%.

Apart from investors chasing safe haven investments in light of the continuing European debt crisis and threats of renewed recession in the US, I believe these low rates also point to a growing expectation that the outlook for the global economy is deflation, not inflation.

This goes against traditional economic theory, which says that pumping lots of extra money into an economy will lead to inflation. While it is true that food and energy are rocketing, the price of manufactured items from clothes to stereos to motor vehicles is falling.

As much as I like the idea of prices falling, a deflationary spiral is much more dangerous and harder to fix than an inflationary one. Also, it punishes those with debts because the real value of those liabilities goes up over time. Given the issues we face with sovereign and household debt globally, that is something to be very, very concerned about.

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