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Rate lifting in the US. And why it matters for the UK.

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Before the Fed meeting, markets thought that there was a 2 in 3 chance that the Federal Reserve would raise interest rates in 2015. But there are reasons to think that lifting rates is harder than it looks. Rupert Seggins & Marcus Wright look at some of the arguments around why US interest rates were left unchanged and could stay lower for longer. They also describe why this matters for interest rates in the UK.

Published in: Economy & Finance
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Rate lifting in the US. And why it matters for the UK.

  1. Rate-lifting in the US. And why it matters for the UK Rupert Seggins & Marcus Wright RBS Economics (@RBS_Economics) September 2015
  2. Before the FOMC meeting, markets put a 64% chance on the first rate rise happening this year 2 But too much focus on this misses a bigger point. US rates could stay lower for longer. ‘Lower for longer’ doesn’t necessarily mean interest rates cannot go up. It can also mean central banks trying to raise rates a little, before seeing them forced back down soon after. 0% 10% 20% 30% 40% Probability 1st rate rise happening in*... Source: Bloomberg. *Blank entries are months in which there is no FOMC meeting
  3. -6% -3% 0% 3% 6% 9% Jan-90 Jan-00 Jan-10 Where the Fed Funds rate is and where it "ought" to be Fed Funds rate that reflects QE Fed Funds Rate Mankiw Rule Some traditional rules of thumb say rates should have risen already 3Source: Macrobond, Mankiw (2001), Wu & Xia (2014). Mankiw rule estimated using period 1990-2008. About 2.5%
  4. 4Source: Bloomberg There is about a 1-in-4 chance that US rates won’t have risen beyond 0.5% by mid-2018 And even if the Fed follows the central expectation, rate rises will be very gradual. Over-focussing on the first rise misses the bigger picture.
  5. 5 Why lower for longer?
  6. Four things making the Fed think twice 6 Inflation is below target Inflation expectations are stable Above average underemployment Earnings growth is not surging -3% 0% 3% 6% Jan-05 Jan-09 Jan-13 US inflation expectations for 5-10 years' time Households Financial markets & finance professionals 0% 5% 10% 15% 20% Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15 Rate of un- and under-employment 2000-2007 average -2% 0% 2% 4% 6% Jan-08 Jul-09 Jan-11 Jul-12 Jan-14 Jul-15 PCE inflation (the Fed's favoured measure) 0% 1% 2% 3% 4% Mar-07 Mar-09 Mar-11 Mar-13 Mar-15 Average hourly earnings (%y/y) Source: Macrobond, Bloomberg
  7. Source: Macrobond, Bloomberg China is a big disinflationary force for the world • Chinese export price inflation explains a lot of what’s going on at the moment • Cheap goods from China were a key factor in the pre-crisis world of low inflation, low interest rates and increased risk- taking. They still are. • China’s slowdown has so far led to a drop in oil and raw materials prices and a world trade recession. Both mean less inflation for us. 0 10 20 30 40 50 60 70 1971-85 1986-98 1999-2013 Causesof Inflation Variability in Advanced Economies(%) Inflationvariabilitycausedby the same common factor Inflationvariabilitycausedby Chinese exportprices
  8. Source: Financial Stability Board, Macrobond, Bloomberg Quantitative easing is going to continue in Europe and Japan Central banks are keeping rates down by buying up government bonds (Quantitative Easing or QE). While QE may have come to an end in the US and the UK, the European Central Bank will be carrying on until Autumn 2016. The Bank of Japan’s programme is open-ended. 0 20 40 60 80 100 120 140 160 180 200 2009 2010 2011 2012 2013 2014 2015 Central bank purchases ($Bn) Fed Bank of England Bank of Japan Bank of Japan Forecast Purchases ECB ECB Foreast Purchases
  9. 9Source: Bloomberg, Macrobond Recent history may worry the Fed 4 7 7 9 15 17 19 21 22 24 25 25 26 38 55 Turkey (Jan-14) Denmark (Apr-11) Eurozone (Apr-11) N. Zealand (Jun-10) N.Zealand (Mar-14) Sweden (Jul-10) Chile (Jun-10) Hungary (Nov-10) Poland (Jan-11) Korea (Jul-10) Australia (Oct-09) Israel (Aug-09) Norway (Nov-09) Iceland (Sep-11) Canada (Jun-10) Number of months from 1st rate hike to first rate cut Of the OECD central banks that raised rates after 2008, all have either lowered or begun to lower them again
  10. 10 Why is this important for UK interest rates?
  11. The Fed & The Bank of England – peas in a pod 11 0% 5% 10% 15% 20% Nov-72 Nov-82 Nov-92 Nov-02 Nov-12 US & UK policy interest rates Bank Rate Fed Funds Target Rate Source: Macrobond This is not surprising considering: 1) how much UK trade and finance goes to the US and back 2) the US’ position at the centre of the world financial system.
  12. US borrowing costs influence UK ones 12Source: Macrobond Whatever the Bank of England does, many of our interest rates could be affected anyway. For example, UK government bond yields track US yields closely. 0 5 10 15 20 Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07 US & UK 10 year government bond yields (%) UK US
  13. Follow us on Twitter 13 @RBS_Economics https://twitter.com/rbs_economics Or visit us online
  14. 14 Disclaimer This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by RBS and RBS makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of RBS’s RBS Economics Department, as of this date and are subject to change without notice. The classification of this document is PUBLIC. The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. © Copyright 2015 The Royal Bank of Scotland Group plc. All rights reserved

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