An extended period of low interest rates and abundant liquidity inevitably generates the fear of a resurgence of the high levels of inflation that we have witnessed in the past. Given the current situation, these fears are unwarranted. In most advanced economies, capacities are still underutilised and output gaps are set to close only very gradually (chart 12). Money, despite having been made available by central banks in unprecedented amounts, has not showed up proportionally in investment and consumption. This reality implies that inflation pressures will be contained for some time to come. Moreover, central banks have the necessary instruments at hand to counter inflation pressures, if and when they manifest themselves. The implication for our analysis is that the inflation premium in interest rates is set to remain small in the future.5 But even though the currently low policy rates are adapted to current economic realities and do not pose a threat to price stability in the foreseeable future, they may pose a risk to financial stability through various channels. First, by lowering the cost of credit and increasing the value of assets, low interest rates could provide the breeding ground for asset price and credit booms. In this regard, the current developments in Swiss mortgage and real estate markets are telling: real estate prices and mortgage credit have been growing with considerable momentum for several years already. Importantly, the growth rates of both prices and credit volumes are at levels which cannot be fully explained by fundamental factors.
Households, governments and banks in many advanced economies are still in deleveraging mode, and this attempt to reduce the debt overhang is likely to weigh on short-term growth prospects. Moreover, persistently high  8  Cf., e.g., Adrian and Shin (2009). 9  Cf., e.g., Miller et al (2002). 10  Cf. Tinbergen (1956). BIS central bankers’ speeches  5  unemployment rates and tight financial conditions continue to dampen consumption spending and business investment in several euro area countries. Against this background, the Swiss economy is expected to continue its expansion in the quarters to come. Available indicators hint at a fairly robust second term in 2013. For instance, monthly data show that exports are gaining momentum, driven by the strengthening of foreign demand. For 2013, we expect the Swiss economy to grow between 1.5% and 2%. Despite this moderately optimistic outlook, we must be aware that downside risks remain substantial. Let me name three: first, structural problems in Europe persist, and could cause new market tensions. In particular, the European banking system remains vulnerable. Second, a negative fiscal shock in the US in early 2014, caused, for instance, by renewed political deadlock over public budget negotiations, would probably be a drag on the global economy. Third, adjustments of the monetary policy stance in one area (e.g. the US) may create undesired spillovers in other regions (e.g. emerging markets or Europe). This could lead to increased volatility in financial markets. What does this economic outlook imply for the likely evolution of interest rates?