Energy crisis, inflation and AI are driving up interest rates

Over the past month, long-term interest rates have soared almost everywhere, particularly in the United States but also in Europe. Yields on 10-year US Treasuries, which serve as a benchmark for international markets, have risen by around 55 basis points, to over 5.2 per cent. This is a higher level even than in 2022, when US inflation was in double figures. On this side of the Atlantic, yields on all long-term government bonds have risen, starting with French bonds (65 basis points), followed by Belgian bonds (48 basis points) and Italian bonds (45 basis points). The Italian spread has approached 130 basis points, whilst the French spread has neared 160. The financial markets are beginning to show signs of concern.

These developments raise three key issues. The first concerns the cause of this turn of events. In reality, it is a combination of factors. Among these is the expectation that inflation will remain higher than forecast for an extended period. Following the outbreak of the war in Iran, there was a false hope that the conflict would be brief, as the negative effects would have jeopardised the US mid-term elections. Instead, the conflict has dragged on, partly because its outcome no longer depends solely on the will of the US president. Another significant factor is the markets’ fear that central banks lack the necessary autonomy to tighten monetary conditions and combat inflation. This fear has been partly dispelled by the decisions taken not only by the ECB and the US Federal Reserve, but also by the Bank of Japan, which is notoriously reluctant to raise interest rates. The deterioration in public finances in most advanced economies – particularly in the United States, Germany and France – has also contributed to the rise in long-term interest rates.

The political difficulties in stabilising the debt are prompting fund managers to reduce their positions, particularly in the run-up to elections. Private debt has also risen, notably to finance the enormous investments linked to the development and growing use of artificial intelligence. In short, long-term interest rates are rising not only because of falling demand – some speak of a ‘sell-off’ – for fixed-rate bonds, but also because of an increase in supply.

The second issue concerns the impact on the real economy. Is it possible to continue growing with such high interest rates? The answer depends on the economic sectors. In the more dynamic sectors, linked to AI, the prospects for profit growth make it possible to sustain higher levels of debt. In the more traditional sectors, however, linked to household consumption, it is more difficult to bear the burdens associated not only with higher interest rates but also with inflation. A typical example is the property sector, which is highly sensitive to financing conditions. It is no coincidence that consumer confidence has begun to fall again over the last two months, both in Europe and in the United States. The enormous flow of investment into the technology sector, increasingly financed by debt, is creating a crowding-out effect to the detriment of traditional sectors, driving up their costs – particularly those of energy and debt. This phenomenon is similar to the ‘Dutch disease’ of the 1970s, when, in the Netherlands, the disproportionate growth of one sector (the energy sector) plunged other sectors, particularly manufacturing, into crisis.

Final point: what should economic policy do in this context? Fiscal policy must avoid a further increase in debt, which would only serve to fuel inflation. Instead, it must reassure investors about the government’s creditworthiness. As for monetary policy, its primary objective remains to combat inflation. At the same time, it must avoid a vicious circle between the trend in long-term interest rates and market confidence, which would lead to financial instability. It is precisely for this reason that it is difficult to understand why the European Central Bank continues to reduce its balance sheet – so-called ‘quantitative tightening’ – which exacerbates the imbalance between supply and demand for government bonds, causing long-term rates to rise further.

The time has come to take a break, as the other major central banks have decided. It is also difficult to understand why, in such a delicate market situation – with tensions that could escalate, particularly in the run-up to elections – the governments of European countries have begun to discuss openly the replacement of the ECB’s leadership, more than a year ahead of the scheduled deadline. Now more than ever, we need to stay the course. And avoid improvising.