Interest rates at record lows, what now?

Last week the central bank of Poland reduced interest rates by a full 0.5% with the headline rate now standing at an all time low of 1.5%. Most commentators believe the main reason for the move is the fact that the Polish economy is dangerously close to deflation. Now the reason deflation is a bad thing is the fact that consumers hold off purchases expecting proces to fall and manufacturers reduce stock. Which causes a down turn. So maybe holding interest rates relatively high was a bad move (hindsight is of course a wonderful things).

The question however remains as to whether near zero interest rates will in fact encourage businesses to borrow for investment and for consumers to buy more goodies (such as TV’s) on credit. As far as consumers are concerned it would appear that the major consideration with credit purchases is the amount of monthly repayments and not the rate of interest. For a short while the news of interest rate reductions can cause a feel good factor and of course for those with significant mortgages their disposable income increases. For corporations the key issue remains whether they believe that investment will pay off and whether the banks will be willing to lend.

There is another aspect to the equation. The central banks world wide primarily look to keep inflation within a narrow range. All well and good but what do the indexes measure? The average shopping basket which in a quickly changing world soon becomes misleading. And of course the inflation indicators do not measure asset inflation. With surplus funds looking for a home we have already seen a dramatic increase in house prices in the UK (well the South East at least). Stock markets have also bounced back.

But what of Poland? Will businesses invest in research and development and new technology as we are told is vital to achieve the next level of growth? Only if they believe there will be a market for the products. John Palmer from BNP Paribas Real Estate reports in a current review that the yield rate on Polish logistics properties has fallen to 7.15% to 7.25% having previously tested double figures and vacancy rates have dropped to 5.7%. The yield rate shows clearly that investors are back in the market whilst the fall in vacancy rates suggests that businesses are gearing up for increases in sales and hence need for warehouse space. Time will tell whether these are the first signs of growth rates increasing.

One of the key issues is that for the demand for employees to grow the Polish GDP has to grow more than gains in productivity. With the government side tracked by the double elections and having fallen into the trap of acceding to demands from public employees (miners amongst others) there is little chance that the still remaining barriers to business are removed any time soon.