It may partly reflect very low levels of current policy rates and any spillovers from that.3 It may also reflect the term premia for inflation that are currently very compressed in some countries, for example, the US and in the Euro area. And it may also be a symptom of a more entrenched pessimism – an over-pessimism in my view – about long-term economic prospects, possibly due to fears of the de-integration of the global economy or concerns about future effectiveness of monetary policy. But, more fundamentally, the very low level of market interest rates reflects an underlying structural trend – the fall in long-run real interest rates since the early 1980s4 – that has been the subject of a great deal of research. The literature has identified a large number of candidate explanations – both real and financial – for a structural decline in the long-run real interest rate. These include: demographic trends and, in particular, increased longevity; lower trend productivity growth; the liberalization of financial intermediation and an increase in the risk borne by individuals and households.5  The long-run equilibrium real interest rates determined by these factors are, of course, unobservable. There is a range of estimates for how far they have fallen.
5  All speeches are available online at www.bankofengland.co.uk/news/speeches  5  In the banking sector, lower interest rates across the cycle reduce the net interest margins (NIMs) that banks earn from liquidity and maturity transformation. Moreover, NIMs would come under greater cyclical pressure more frequently and for longer because a proportion of banks’ liabilities pay no interest and cannot therefore come down to match a reduction in lending rates when the policy rate is cut.8  It is also possible that the yield curve will be flatter in a low for long environment as greater proximity to the zero lower bound of interest rates will mean less interest rate variability on average across the cycle leading to lower term premia. If so, this would further reduce banks’ earnings from maturity transformation. In Japan, a prolonged period of low interest rates has contributed to falling NIMs for over a decade. More recently, we’ve seen a similar – albeit smaller - effect in other advanced economies9. The impact of lower NIMs on bank profitability is currently reflected in lower price-to-book valuations of banks.10 Arguably, in ‘steady state’, once expectations of returns have adjusted downwards to a low for long environment, target returns on bank equity will adjust accordingly, though there is no evidence of this happening so far. We should expect, even if only for a transitional period if expectations of returns do adjust, greater pressure on banks to search for yield and move further out on the risk curve.