Will Britain or America raise interest rates first?
When rates start to rise both sides of the Atlantic, they won't increase by much
By H.C. | LONDON
AMERICAN and British central bankers face a similar tough choice. On both sides of the Atlantic, the economy is growing moderately, and unemployment is closing in on 5%. As a result, wage growth is picking up. But inflation remains low: 0.2% in America and zero in Britain, according to the central banks’ respective preferred measures. And nobody is certain how much slack remains in labour markets—a key determinant of inflationary pressure. In this mixed environment, when is the right time to raise rates? And which rate-setters will go first?
First, take growth. This week new GDP data on both sides of the Atlantic showed continued—if unspectacular—growth. America’s economy expanded at an annualised pace of 2.3% in the second quarter. It did not shrink in the first quarter, as previously thought. So far in 2015, America has grown at a 1.5% annualised pace; buoyant Britain has managed 2.2%.
Both demand and supply affect GDP growth, making it hard to judge whether the economies could do better. Debate rages about long-run supply potential in the aftermath of the financial crisis. Jeb Bush, the frontrunner for the Republican nomination, thinks 4% growth is achievable. Few economists agree. In Britain Chris Leslie, the opposition Labour Party’s finance spokesman, has also called for more ambition. In any case, unemployment is a better barometer for the demand-side of the economy. In America, it has fallen to 5.3%; in Britain it is 5.6% (though it increased slightly last month). In both cases, it is close to what the central bank’s estimate of the equilibrium level. But rate-setters emphasise the importance of broader measures of labour market slack, such as the number of part-time employees who want a full-time job.
This week, the Federal Reserve said slack had “diminished” since the start of the year. Some have interpreted that as a signal for a rate rise in September, as most economists expect. It certainly leaves the door open for a rate rise. But traders have a different opinion; futures markets suggest rates will not rise until December. One advantage of such a delay is that by then—with the Fed having repeatedly stated it expects rates to rise this year—a change in policy will be fully expected. In September, by contrast, traders will be on tenterhooks. With policymakers fretting about the impact of the first rise, especially on emerging markets, predictability is desirable.
Many have argued that the Bank of England will wait for wheels-up at the Fed before starting Britain’s take-off. One reason is the exchange rate. Were the bank to move first, the pound would probably strengthen against the dollar. That could cause more deflationary pressure immediately, pushing the bank further off-target in the short run.
But the bank has long resisted the idea it is waiting for the Fed. And with Mark Carney, the bank’s governor, and other members of the interest-rate setting committee making hawkish noises recently, it is possible the bank could raise rates to coincide with its November inflation report. If the Fed holds fire in September, the bank could find itself going first.
The frenzied speculation will only increase over the next few months. Some complain that the two central banks are not being explicit enough about their plans. In particular, the Fed declined to provide much more guidance this week. But the importance of the exact date of lift-off is overstated. It matters most for traders concerned with making a quick buck. The stance of monetary policy is reflected by the entire expected path of interest rates, not just the timing of any one move. And both central banks have made clear that take-off will be very gradual—whenever it begins.
