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Could central banks’ inaction cause an economic firestorm?

There has already been much speculation about central banks’ reluctance to lower interest rates. While the US, UK and Europe remain cautious by keeping interest rates the same in fear of reigniting inflation, it could cause irreversible damage to indebted sectors, like the commercial property sector.

Economists predicted interest rate changes in March, but it seems that central banks are only expected to lower rates in May and possibly the second half of the year.

This hesitation comes as these central bank chairs were attacked for taking too long to respond to high inflation. FED Chair Colin Powell stated that he would be prudent in cutting rates, while European Central Bank Chair Christine Lagarde warned of a ‘long beach’ before the first rate cut. The fear of rising interest rates seems to have left central banks paralysed.

Unfortunately, inflation-adjusted interest rates are soaring. Real rates discounted by inflation have risen to over 1000 basis points in the US and similarly in the UK and Europe.

Morgan Stanley estimates that property developers would have to refinance $2 trillion in debt by the end of 2025, with regional banks liable for a third of it. Frozen or higher rates could cause a financial collapse. Sweden’s SBB and Germany’s Deutsche Pfandbriefbank are on the verge of collapsing, while Austria’s Signa has already collapsed. There is a huge funding gap, which is the difference between the original loan amount and the cost of refinancing at higher rates. In Europe alone, the funding gap is over €90 billion.

The dilemma is that one in five mortgage rates will mature in 2024 in the US alone. This is a 28% rise in matured loans since last year. This pressure on developers and banks could see many smaller regional banks collapsing if interest rates don’t get lowered soon.

The collapse of the commercial property sector could significantly impact other sectors closely related to or dependent on real estate. All we can do is monitor central banks and hope that rate cuts occur sooner than later.

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