As inflation has fallen, central banks have started to reduce interest rates. Switzerland led the way, cutting rates in March and again earlier this month. Sweden moved in May and, earlier this month, the euro area and Canada cut rates for the first time in this cycle. Financial markets expect the Bank of England to follow suit in August and the Federal Reserve to do so in November.

Interest rates may be heading down but this is unlikely to mark a return to the sub-1 per cent interest rates that were the norm in the West before inflation surged.

The exceptional forces that drove interest rates to record lows are dissipating. The hyper-globalisation of the 1990s and early 2000s that helped drive import costs lower is over. Geopolitical tensions and a greater focus on national autonomy have created new frictions and costs in the global trading system which are likely to add to inflation. China’s population boom, which helped drive industrialisation and a surge in cheap imports to the West, has also run its course. In China and the West, a shrinking pool of workers and growing demand from an ageing population suggest that wage pressures, and therefore inflation, are likely to remain elevated.

The demand for capital is shifting too. Before the pandemic, investment ran at low levels in rich countries, depressing demand for capital and interest rates. Today the energy transition and the need for investment in defence, technology and supply chains require vast levels of investment. Although the pandemic has passed, governments are continuing to borrow on a vast scale to fund spending. The IMF forecasts that the US will run a budget deficit in excess of 6 per cent of GDP for the rest of this decade. This is not a US phenomenon. IMF forecasts show all G7 countries posting deficits through to the end of this decade.

Governments fund themselves by issuing bonds. Since the financial crisis that process has been made easier by the fact that, in most western countries, central banks have been buying government bonds in an effort to lower market interest rates and prop up demand. But with the pandemic past, and the financial crisis a distant memory, central banks want to tighten monetary policy. To do so the Federal Reserve, the European Central Bank and the Bank of England are selling their stocks of government bonds into the market. Just as quantitative easing reduced interest rates so unwinding the policy leads to higher interest rates. This is likely to act as an upward force on market interest rates for several years.

The other exceptional forces that have born down on interest rates were the financial crisis and then, 11 years later, the pandemic. Central banks sought to counter the devastating effect of these shocks by collapsing interest rates. If the global economy avoids shocks on this scale – and we would be unfortunate to do so again in the next few years – central banks are likely to run interest rates at higher levels.

Financial markets think that the era of cheap money is over. In the US and UK, ten-year bonds currently yield just over 4.0 per cent. That suggests that markets currently see interest rates averaging somewhere around 4.0 per cent over the next ten years.

That would represent a large increase in the cost of capital compared to 2009-21. It’s a change that would have implications for debt levels, asset prices and the structure of household and corporate balance sheets. We need to be ready for a new era of higher interest rates.

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe and/or view previous editions of Deloitte Monday Briefing here.