Central banks may find it difficult to increase interest rates. Reduction of central bank purchases of bonds also risks higher rates and reduced available funding. Low rates have allowed over extended companies and nations to maintain or increase borrowings rather than reducing debt levels, but levels of debt encouraged by low rates become rapidly unsustainable at higher rates.

If sustained, the 1% rise in rates would increase the debt servicing costs of the US government by around US$170 billion. A rise of 1% in G7 interest rates increases the interest expense of the G7 countries by around US$1.4 trillion.

Central banks also cannot sell government bonds and other securities held on their balance sheet. The size of these holdings means that disposal would lead to higher rates resulting in large losses to the central bank as well as banks and investors. The reduction in liquidity would exacerbate this by sharply tightening the supply of credit, destabilising a fragile financial system.

According to the Bank of International Settlements, a 3% increase in government bond rates would result in a change in the value of outstanding government bonds ranging from a loss of less around 8% of GDP for the US to around 35% for Japan.

One constraint may be the potential loss on investments for a given rise in rates consistent with the central bank maintaining its operational ability and credibility.

The US Federal Reserve has US$54 billion in capital supporting assets of around US$4 trillion. The ECB has Euro 10 billion in capital supporting assets of Euro 3 trillion. The BoJ has around Yen 2.7 trillion in capital supporting assets of Yen 160 trillion. The Bank of England has Pound Sterling 3.3 billion in capital supporting assets of Pound Sterling 397 billion.

In effect, a small change in asset values would significantly impair the capital base of these institutions.

Source: Satyajit Das, Economonitor.com 31 March 2016