The era of near-zero interest rates may not be over, but PE shouldn’t celebrate this

Today the Bank of England decided to keep its policy interest rate held at 4.25%, but hinted it would reduce it further in August (it’s been cut four times over the past year, from its peak of 5.25%). Over on the continent, where inflation is lower, the European Central Bank recently cut its main rate to 2%, whilst Switzerland, which saw deflation of 0.1% in May, has cut its rate to zero. The US Federal Reserve is keeping its rate held at 4.4%, in the face of uncertainty over how much tariffs will push up inflation.

Countries which aren’t cutting their rates as fast as the ECB, such as the UK and the US, are holding off because they’re still experiencing above-target inflation. But they’ve still been cutting rates from their 2023/2024 peaks, and expect to continue to do so as inflation is brought under control.

No one is quite sure where interest rates will end up, but a bit of a consensus has emerged amongst economists that it is unlikely we will return to the situation of the 2010s, where rates were held at or close to zero in the face of persistently low demand and below-target inflation. Advanced economies are now supply-constrained rather than demand-constrained, and the huge increases in spending on defense that governments are now promising should only make this more true.

All it would take, however, is a major unexpected shock to the economy to completely change the outlook. A financial crash akin to 2007/2008, or the burst of the dot-com bubble in 2000, could cause a negative shock to demand, as businesses reduced investment and laid off workers and households cut back spending, which would put pressure on central banks to rapidly cut rates to support the economy, even if inflation remained around the 2% target.

Private equity (PE) firms, who relished the cheap debt of the 2010s as it allowed them to do ever-more-leveraged buyouts, might see a silver lining in this. Deal activity in the PE industry drastically slowed in 2023 and 2024 due to higher interest rates, and PE firms have been holding onto assets for much longer than they normally would. Some fund managers may even be cynically waiting for the next financial downturn and interest rates to fall before selling.

But lower interest rates would offer only minor, temporary relief. The PE industry’s deeper problem is that, similar to the housing market, the valuations of illiquid PE-held assets aren’t really ever allowed to properly adjust downwards, because returns are being driven to a significant extent by asset price inflation. PE firms, like house sellers, will tend to rather hold off selling than accept a significant price reduction, which causes markets to freeze when conditions aren’t favourable.

Eventually, something will have to give. Hedley Goldberg, Partner and Global Head of Healthcare Services at investment bank Rothschild, said at HBI’s conference in March that PE “needs to see realisations this year”. Hopefully it’s a relatively calm and orderly amble towards the exit, rather than a chaotic and panic-induced scramble.