The era of cheap money is coming to an end – markets aren’t ready
The era of historically cheap money is ending, forcing a potentially permanent adjustment to higher equilibrium interest rates that will challenge financial markets and government finances built on past assumptions, says Damian Pudner
For almost a decade until the pandemic, financial markets priced money as if it would remain cheap indefinitely. Governments borrowed freely, financial assets soared in value, and abundant credit became a structural feature of the economic landscape.
That assumption now looks increasingly fragile.
The question confronting investors is no longer simply where interest rates will settle through the cycle. It is whether the underlying price of money has shifted onto a higher trajectory. If it has, the implications extend well beyond central banks into sovereign debt dynamics, financial stability and the valuation framework underpinning financial markets.
Cheap money shaped behaviour across the entire financial system. Its withdrawal will do the same.
The prolonged period of exceptionally low borrowing costs that followed the Global Financial Crisis was historically unusual. Real interest rates have typically been positive, often materially so. Decade-long periods of ultra-cheap capital are historically rare.
This environment was not engineered by central banks alone. It reflected deeper structural forces. Productivity growth slowed, reducing the expected return on investment. Ageing populations increased desired saving, while strong global demand for safe assets compressed yields. Put simply, the world was saving more than it was finding productive ways to invest.
That balance now appears to be shifting.
Government borrowing is at record levels and is unlikely to fall soon, forcing heavy calls on global savings just as vast investment requirements – from energy infrastructure to defence capacity – intensify competition for capital.
The assumptions that underpinned hyper-globalisation look less secure. If so, the implications extend far beyond central banks. A structurally higher neutral rate would influence mortgage costs, corporate investment, asset valuations and the fiscal arithmetic facing governments. When the price of money changes, the structure of the economy tends to adjust with it.
Markets adapt quickly. Financial structures do not. Balance sheets built during an era of cheap money embed assumptions about refinancing costs, discount rates and liquidity that are inherently slow to change. By the time regime shifts are widely recognised, repricing is usually already underway – increasing the risk of policy error.
Those assumptions are now being tested.
Recent remarks from Bank of England chief economist Huw Pill underscore the uncertainty confronting policymakers. His warning that cutting rates prematurely could prove a policy error points to a risk markets may be underestimating – that the neutral rate itself is higher than previously assumed.
For central banks, this creates a difficult constraint. Policy must restrain inflation without tightening into a neutral rate that may itself be drifting upward. That is a far more complex exercise than conventional rate-cycle narratives imply.
The fiscal implications alone deserve serious attention. Independent central banks operate within fiscal states, not outside them. Higher debt levels mean interest-rate movements now carry significantly larger budgetary consequences and narrow the room for policy manoeuvre.
No wonder talk of fiscal dominance, once largely academic, is quietly returning to mainstream policy discussion. This is when the central bank must take account of the government’s financing needs to such an extent that maintaining price stability becomes secondary to ensuring debt sustainability.
Lessons from history
History is unequivocal. Periods of stability encourage leverage, invite excessive risk-taking and compress risk premia – often until markets forget why those premia existed at all.
The real mistake is to assume that the monetary conditions of the past decade were permanent rather than an anomaly.
None of this implies that rates will remain permanently elevated. Cyclical downturns will still pull borrowing costs lower at times. But equilibrium rates may settle structurally higher than investors became accustomed to during the 2010s. A more fragmented geopolitical order may also introduce greater volatility around that path.
Investors should think less in terms of point forecasts and more in terms of distributions.
Beyond any single policy meeting, the cost of capital will eventually reflect inflation expectations, wage dynamics, productivity growth, and fiscal credibility.
High debt is manageable. High debt in a world of structurally higher rates is not.
Cheap money shaped a generation of financial behaviour. The global economy now appears to be entering a more expensive era of capital – and balance sheets built for the old world may not withstand the discipline of the new.
Markets are patient. But they are rarely patient indefinitely.
Damian Pudner is an economist