Pound plunges after Bank of England's dovish rates signal

Interest rates: the case for and against a Fed hike

16 September

If you've got even a passing interest in markets, you'll know there is a pretty important meeting taking place later on today among US central bank rate-setters, which will tomorrow result in a decision to either hold interest rates or finally tighten policy.

The decision is too close to call. Investors are currently betting on a hold, while economists are split down the middle and there are compelling arguments on both sides. So what is the case for and against action?

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Why rates should be held

"The case against raising rates now is fairly simple: inflation is below the target, and while unemployment keeps dropping, wages aren't increasing significantly," says the Huffington Post's Ben Walsh.

Inflation is virtually stagnant amid falling oil prices, so if you consider containing it to be the main reason to increase rates then there is no real argument for doing so. Wage rises hit 2.4 per cent last month, but the up-tick is from a recent low base and so there is little evidence yet that this is building underlying cost pressures.

Then there is the global context. "There have been wild swings on financial markets in recent months and signs that the global economy is losing momentum," says The Guardian.

"The market turmoil stems from China, where an economic downturn has coincided with a stock market rout," says the paper. This may weaken the prospects for the US – and elsewhere – further adding to the case to keep policy accommodative.

Finally, what of the impact on emerging markets, which have amassed big dollar denominated debt piles in recent years while rates were low and could suffer if the rug were suddenly pulled?

Why rates should rise

Despite all this, the US economy "looks rosy" and "appears to have put the global financial crisis behind it", The Guardian notes, adding that "unemployment is at 5.1 per cent, the lowest since March 2008", while GDP rose at 3.7 per cent in the second quarter, the fastest in the developed world.

To the extent that the Fed should focus on domestic policy and respond to its own underlying performance, this presents a strong case.

What about those market wobbles? Well there is an argument that the now interminable debate over when the US will move rates is contributing to uncertainty and that "pulling the trigger at last would actually remove some of the volatility".

The Financial Times cites analysts claiming ‘Fed fatigue’ is behind unexpected and contradictory market trends at the moment. Some even challenge the view that rates should be held, to prevent rocking the recovery, at home or abroad.

The Bank of International Settlements has warned that low rates are to blame for the debt bubble in emerging markets and that it would be better to lance the boil now, while others point out that if the US economy were to head south there are no policy levers to pull all the time rates remain stuck.

Where are we really?

Maybe all of this ultimately comes down to how fragile we really thing our recovery is – if it's well set, it will handle a modest increase in rates. As Chuck Jones writes for Forbes, "if the economy and financial markets can't take a 25 basis point increase with the outlook that future increases will be gradual and slow then we are much worse off than we think we are".

Interest rates: will zero inflation delay rise?

15 September

Analysts are again talking up the chances that UK interest rates will be held lower than the Bank of England is currently intimating, after inflation dropped back to zero again in August.

The BBC reports the Office for National Statistics has revealed the consumer price index measure of inflation, which is used for most official forecasts, fell back from the already moderate 0.1 per cent in July to zero.

This had been widely expected and continues a prolonged run stretching back to February of at-or-near zero price rises.

An ongoing slump in oil prices, which hit a six-year low close to $42 a barrel in August, and continued food price deflation amid a supermarket price war were cited as the key factors in the reduced rate last month. Clothing costs also rose by less than expected for the month.

Those who believe it is too early to begin tightening monetary policy are seizing on the fall to call for the Bank of England to delay an expected rates rise, which it has intimated may come in the early months of 2016.

They are also citing a modest fall in 'core' inflation, which strips out food and energy prices, to one per cent and weak manufacturing data pointing to a softening in the UK recovery.

But the Bank's governor, Mark Carney, has already dismissed concerns over China and the global economy and may focus on wage growth and corollary underlying price pressures rather than what he has said is a short-term inflation trend.

The US Federal Reserve faces a similar dilemma when it meets this week, with data consistently showing the labour market is healthy and the US recovery among the strongest in the developed world.

Central bankers are generally keen to ensure they do not wait too long to increase rates, which the Bank of International Settlements have warned have contributed to a bubble in cheap dollar-denominated debt.

The BBC's Robert Peston says "if the Fed's members are indecisive, it is difficult not to sympathise".

He adds that the psychological fact of rates rising has now become an obsession for markets: "Who knows quite how anxious we will feel when confronted with the harsh reality that interest rates can rise as well as fall?"

Interest rate hike will hit developing economies

14 September

If rate setters at the US central bank vote to increase borrowing rates soon there will be a "spillover" effect for emerging markets that have taken on huge sums in dollar-denominated debt – but this should not deter a rise to begin the necessary return to normal monetary policy.

That is the view of the widely-respected Bank of International Settlements (BIS), which has published its latest quarterly report. The Financial Times reports that the venerated institution, which predicted the last banking crisis and is often referred to as the central bank for global central banks, cites a worrying dependence on loose policy across in developed markets.

Revealing that emerging markets took on $3,000bn in ultra-cheap dollar debt in the first quarter of this year alone, the BIS report says "financial markets have worryingly come to depend on central banks’ every word and deed, in turn complicating the needed policy normalisation".

Claudio Borio, head of the BIS Monetary and Economic Department, added it is "unrealistic and dangerous to expect that monetary policy can cure all the global economy’s ills".

The Bank says there will be knock-on effects in economies that have borrowed heavily and that "easier domestic financial conditions will be reversed", hitting growth.

But action is needed and a slowdown in expansion in the developing world, especially in China, merely reflects "the release of pressure that has gradually accumulated over the years along major fault lines".

The Federal Reserve meets on Wednesday and will announce its latest policy decision on Thursday. Investors now believe rates will be held, but many analysts still reckon on a rates rise to begin a slow, gradual process of fiscal tightening.

The Bank of England might not be too far behind. Writing in Scotland on Sunday at the weekend, one rate setter, Martin Weale, said a rates rise would be needed sooner to combat a long-term rise in inflation over the coming years, driven by domestic pricing pressures.

This was echoed by fellow committee member Kristen Forbes, who said in a speech reported by the Daily Telegraph that increases in the value of the pound do not drag on inflation as in the past and that as a result the model for rates increases would need to be accelerated.

Interest rates: Bank of England stands firm despite global wobble

10 September

The message is largely "as you were" after the second deluge of Super Thursday interest rates information from the Bank of England.

As in August, just one of the nine members of the Monetary Policy Committee called for rates to rise from their historic low. And despite market unrest related to a worsening outlook for China and a related marginal reduction in forecast UK growth, due to expectations of falling exports, the bank remains committed to its "central forecast". That implies a rate rise in early 2016 following by gradual increases thereafter.

Nobody had expected rates to rise this month – and so it proved, with the committee voting eight to one against. The lone voice calling for a rise was noted hawk Sir Ian Macafferty, whom the Financial Times says argued an earlier rate rise would "would facilitate a more gradual path for policy tightening".

Minutes were poured over for any signs that rate setters might be more cautious in the wake of market turmoil caused by concerns over China, where growth is slowing, prices are falling and domestic demand is thought to be on the wane. The Daily Telegraph notes that the minutes cite China's "sizeable standing" and acknowledge that the UK would not be "immune" to a downturn in the world's second largest economy. However, they conclude that "developments did not as yet appear sufficient to alter materially the central outlook".

Committee members also said that the uncertain global backdrop had be weighed against an improving domestic picture, in which underlying demand was growing, "underpinned by robust real income growth, supportive credit condition, and elevated business and consumer confidence."

While the bank reaffirmed its plan to increase rates at a slower pace than in previous cycles, the BBC notes its warning that "this guidance is an expectation, not a promise".

Interest rates: seven reasons the Fed might act

9 September

Major global institutions are all lining up to tell Federal Reserve rate setters not to increase the benchmark borrowing rate when it meets next week.

After an earlier warning from the IMF (see below), today it was the World Bank which warned of "downside risks" related to the apparent slowdown in China. The bank's chief economist told the Financial Times that a move to raise rates, following recent stock market falls and at a time of brittle confidence, could catalyse "panic and turmoil" across emerging economies, many of which have large dollar-denominated debt piles.[[{"type":"media","view_mode":"content_original","fid":"84334","attributes":{"class":"media-image"}}]]

In spite of all the high profile figures coming out against a rise, the decision could go either way. Most traders reckon there is at least a small chance of a move in rates for the first time in nine years, while some reports say odds are even. But why would the Fed consider a rise given these alarming statements?

1. The Federal Reserve "is not the world's central bank", says Roger Bootle in the Daily Telegraph. Its remit is to "set monetary policy in the interests of the US alone" and rate setters should only consider the wider macroeconomic picture "in so far as it might affect the US economy".

2. Stock markets do not reflect the real economy. Bootle adds that it would be a mistake "to allow monetary policy to be dictated by movements in stock markets", which are volatile, short-termist and do not reflect the wealth of real citizens, who are often very far removed from them. Again, such movements should be considered only if they "threaten major developments in the real economy".

3. Jobs figures make the economy look healthy. Despite the fall in US employment in August, jobs creation in the US has been positive for 66 consecutive months and Reuters notes the unemployment rate is at a seven-year low. Wages are rising faster than expected, too.

4. There is a lag effect, which means "preventative action" may be required that ignores headline inflation rates. That was the view of Kristen Forbes, who said a couple of weeks ago (see below) that it takes at least a year for the effects of a rates rise to filter down and so central banks need to respond to "underlying cost pressures". Wage growth and falling employment would be considered to exert such pressure.

5. Beware of "distortions". The OECD has previously warned that rates being kept at record lows for so long has pushed pension funds and the like to take on more risk than they ordinarily would in search of adequate returns. USA Today cites similar concerns for savers who might be drawn to lucrative-looking investment scams. Essentially, as former Bank of England rate setter Sir John Gieve told The Times, "there is a real danger of waiting too long" to normalise monetary policy.

6. Policymakers could be backing themselves into a corner. Gieve warns there are "perennial" dangers across the global economy, which means there are always risks of changing course. But what about if things got seriously bad again, for example if there was a major crash in China? There are currently few options to boost economies because monetary policy is already so loose.

7. Lance the boil. If we accept rates must be normalised – and the sooner the better – then focus turns to timing. That is where we are now, with global markets obsessing over when the first rate rise might happen. Bootle advises ending this by getting it out of the way now. In any case, it is not the first rise that is important but "the pace of subsequent increases and the level to which rates finally rise".