Interest rates hikes are not done and dusted

July 20, 2015

U.S. Federal Reserve Board Chair Yellen talks with Carney, Governor of the Bank of England, during the G20 finance ministers and central bank governors meeting in Istanbul

The U.S. and British central banks are scrambling to be the first of the majors to raise interest rates after a long period of unprecedented monetary generosity. It won’t happen immediately but both Janet Yellen, who chairs the U.S. Federal Reserve, and Bank of England Governor Mark Carney say there will be a hike this year (Yellen) or around the end of the year (Carney). Might this be a bit of a rush? Not everything in the world economy is as sanguine as the U.S. and British economies purport to be.

In the euro zone, European Central Bank President Mario Draghi has promised rock-bottom interest rates for the foreseeable future and pledged to see through the bank’s monthly 60 billion euro asset purchases until September next year. In Asia, China’s policymakers are struggling to contain stock market mayhem that could still undermine attempts to reverse a growth slowdown. Japan is still embarked on a massive quantitative easing asset-buying programme and has just cut its growth outlook.

Countries as diverse as Sweden, South Korea, Guatemala and Azerbaijan have cut rates over the past three to four weeks. Group of Seven economy Canada, Washington’s closest developed trading partner, surprised by easing last week.

In all, 37 central banks around the world have eased monetary policy so far this year to boost growth, fight deflation or both.  Influential though they are, the Fed and BoE are outliers.

Clearly Yellen and Carney believe that domestic growth, job creation and inflation are on trend to warrant it. But their views are couched in caution. Carney, for example, has said that interest rates will rise only gradually from their record low of 0.5 percent, and to lower levels than in the past. Meanwhile, Yellen told Congress that risks remain, notably from spillover from the Greek and Chinese crises. “The importance of the initial step to raise the federal funds rate target should not be overemphasised,” she said.

The caution certainly comes from outside. China and Greece could easily upset the apple cart. But there is nothing concrete about what is happening in Fed- and BoE-land either. Britain has seen prices bump close to deflation and the jobless rate rise for the first time in more than two years. U.S. manufacturing is expanding but is highly vulnerable to a strengthening dollar. Retail sales fell in June and May was revised downwards, real weekly wage earnings have slipped lately, and inflation remains weak at just 0.1 percent year-on-year.

As for the euro zone, it is still struggling to keep Greece within its fold for fear of suggesting the currency project may not be as permanent as advertised. Growth is ticking up, but expected at only 1.5 percent this year. Draghi was relatively calm about the state of the bloc’s economy at his latest news conference but only talked about interest rate hikes over the coming “years”.

Rate hikes are not done and dusted.

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