Facing a Slump, Central Banks Drop Rates to Push Recovery

Global markets have been in a state of crisis since the start of the pandemic

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Aug 13, 2020
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Global markets have been in a state of crisis since the start of the pandemic, and one sector that's faced particular strain is the housing market. Tenants are backlogged on rent, some banks have deferred mortgage payments, but conditions have, oddly enough, also created a buyer's market. This is a result of broad national stimulus plans driven by global banks.

After several months in the grips of this pandemic, though, many wonder whether these stimulus programs will be enough to push recovery for banks.

Prices up, interest down

The primary reason housing is considered a buyer's market at the moment, at least in the U.S., Australia and Canada, is that these are all places where the central banks have issued policy rate cuts – in other words, they've reduced the cost of borrowing money. This can be tempting to individuals interested in purchasing property because it means the long-term cost, with interest factored in, will be lower.

Central bank interest rates may be down despite the current pandemic, but to the great surprise of many, home asking prices were up 13% in the U.S. recently, according to Redfin. It could be that sellers believe lower interest rates will encourage buyers to accept a higher initial investment, or that pre-Covid economic patterns did enough to drive up prices, even if they then fell again as the pandemic reshaped the market.

Another look at rates

Around the world, central banks have pushed rates down in hopes of stimulating otherwise depressed economies, but how should borrowers evaluate these rates? At the most fundamental level, determining whether borrowers are getting the best rate depends on the same factors as under more conventional circumstances. For example, in Australia, where the central bank has lowered interest rates for purchasing, refinancing and building homes, it may be easy to get an affordable rate on a mortgage, but borrowers should beware variable rates.

Fixed rate mortgages lock the interest rate in place, but variable rates can increase with economic changes – and there's significant concern that, even with lower mortgage rates, Australia's lending rates could still hit a slump. This is remarkably different from the U.S., where home sales have seen record gains this summer; buyers can't turn down such appealing mortgage rates, if they have enough money in the bank. This is notable evidence that the same actions by central banks can yield different results.

Predictions for economic recovery

Mortgage rate adjustments are just one element of the larger stimulus plans being undertaken by central banks, and it's these other factors that may tip the balance in terms of economic recovery. Many countries have taken steps to support the liquidity of their banking systems during this time as well, particularly through the use of capital and liquidity buffers.

Dropping interest rates may be a common central bank response to economic depression, but it's worth noting that the Eurozone didn't alter interest rates at all. That's because many of those countries already rely on an unconventional banking strategy: lending at negative interest rates. Depressing those rates further doesn't actually stimulate the economy, which is why this region has focused their stimulus efforts elsewhere.

Fiscal policy plays a critical role in economic recovery whenever a recession strikes, but that doesn't mean there are one size fits all policies that will help a country recover. This is in large part because different countries manage their individual economies very differently during more ordinary times, as evidenced by the Eurozone's negative interest borrowing rates, for example. Each country must consider, first, which strategies best encourage spending, as well as factoring in the state of the job market. With different parts of the globe in vastly different phases of recovery, economic stimulus efforts need to be calibrated based on local needs and data.

Disclosure: I do not own any of the stocks mentioned in this article.

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