Pimco Sees High Debt Compressing Central Bank Interest Rates

(Bloomberg) -- Central bank interest rates are being constrained by high levels of government debt, according to Pacific Investment Management Co.

Debt levels have continued to rise since the financial crisis, especially in emerging markets, Pimco Executive Vice President Nicola Mai said in a report published Tuesday. His analysis suggests that, as a result, policy rates will need to remain very low to ensure that already high government debt-to-GDP ratios don’t increase further.

“The global economy remains highly levered, and sensitive to interest rate movements,” he wrote. “Debt sustainability hinges on low debt service ratios, which in turn are predicated on persistently low interest rates. This will constrain central bank efforts to normalize rates.”

Mai found that the nominal interest rate required to stabilize that ratio in the U.S. in his baseline scenario would be just 0.8 percent, while in the U.K. it is 1.1 percent. Although his calculations only account for one aspect in which debt affects equilibrium rates, they highlight the need to keep benchmarks low, he wrote. Pimco has previously predicted that rates will stay subdued for a prolonged period under a scenario it has dubbed the “new neutral.”

For markets, his findings suggest that while U.S. and German bond yields can be volatile over the business cycle, duration valuations are likely to remain anchored and there may be limits to how much further Treasury yields can rise.

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