John Lewis
How low are UK real interest rates by historical standards? Using the Bank’s Millennium of Macroeconomic Data, I compute real bank rate, mortgage rates, and 10-year government bond yields over time.
The lines show the five year moving averages of the ex post real interest rate. The dots show the values over the years 2012 to 2016.
Figure 1: Real rates over time
The 5-year average of real bank rate rarely goes below zero – previous instances were mainly during the 1970s inflation and around world wars. The decline in real bond yields since the 1980s leaves them about 300bps below their all time average.
One benchmark to assess how low rates currently are is to compute what nominal rates would be if real rates were at their historical means? To estimate this, I assume inflation of 2%, and real rates reverting to various historical averages. The choice of benchmark matters a lot…
Figure 2: Implied nominal rates if real rates mean revert
Reversion to the all-time average requires Bank Rate to rise by about 450bps, much more than the yield curve currently suggests. For bonds and mortgages, the move is around 250-300 bps. If real rates revert to averages seen in the decade between BoE independence and the financial crisis, bond yields and mortgage rates would increase by nearly 400bps each. Reversion to 20th century benchmarks requires rises about half that size.
Uncovering long-run trends in real rates is tricky, views differ and there’s no economic law that says mean reversion has to happen, but on all these measures, rates are well below historical averages.
John Lewis works in the Bank’s Research hub.
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