Impact of interest rates in the US and the UK heading higher

What a difference a year makes, these are the current 10 year government bond yields,

Figures in brackets indicate change over the past year

US 2.83% (up 0.43%)
UK 1.57% (up 0.27%)
Japan 0.07% (down 0.03%)
Germany 0.74% (up 0.41%)
Canada 2.35% (up 0.62%)
France 0.99% (down 0.04%)
Australia 2.85% (up 0.13%)
Switzerland 0.10% (up 0.22%)
Italy 2.03% (down 0.19%)
Spain 1.48% (down 0.18%)
Portugal 2.08% (down 1.91%)
Greece 4.11% (down 3.41%)

Looks like the zero or negative interest rate regime (details here) is working for some countries.

The US and the UK headed for higher interest rates?

The US Federal Reserve left its benchmark interest rate unchanged during its last meeting on January 31 at a target range of 1.25% to 1.50%. This was the final meeting of the central bank’s monetary policy committee under departing chairwoman Janet Yellen.

The accompanying statement hinted that the Fed will increase the benchmark US interest rate at its next meeting, in late March, thanks to an improving economy and signs of inflation.

Meanwhile, Bank of England Governor Mark Carney has said that interest rate rises will be raised ‘somewhat earlier’ than previously thought.

He was speaking after the latest meeting on February 8 of interest rate policy makers, who decided to keep UK interest rates on hold at 0.5%.

The Bank of England deputy governor added that UK interest rates doubling this year would be ‘no great shock’.

Can the US and UK government really afford higher interest rates?

The US government has around $20.5 trillion in debt and pays around $320 billion in interest payments a year (an effective interest rate of 1.56%).

The US tax revenues are around $4 trillion (Federal revenue only – state revenues not included) a year, which would mean 8% of all tax revenues are paid as interest.

The UK government has around £1.7 trillion in debt and pays around £40 billion in interest payments a year (an effective interest rate of 2.35%).

The UK tax revenues are around £750 billion a year, which would mean 5.33% of all tax revenues are paid as interest. The UK has paid £540 billion in interest since it last ran a surplus in 2001.

Both the UK and US are unlikely to run surpluses any time soon. The UK government has projected to balance its books and generate a surplus in 2025. That surplus target year has changed several times and going by past precedence it should be taken with a pinch of salt.

Now, on the impact of rising interest rates and bond yields. A lot of government borrowing is long term (10 and 30 year bonds being the most popular) so the impact of rising bond yields won’t be felt immediately.

On an average, around 7% of the total debt is rolled over for both the US and UK every year plus new borrowing is made.

A 1% (100 basis points) rise in yields would increase the total interest cost on existing borrowings by 4.8% for the US and by 5.1% for the UK in the first year. Those numbers would be compounded in subsequent years.

“Credit is a system whereby a person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.” – Charles Dickens, Little Dorrit

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