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Why UK interest rates could
stay lower for longer
than you think
Marcus Wright
RBS Economics
November 2015
Slide 2Source: Bloomberg, Macrobond
Of the OECD central banks that raised rates after 2008, all have
either lowered or beg...
What this is about
• Markets expect the Bank of England to start raising rates from
early next year. In 3 years Bank Rate ...
Source: BIS
UK inflation is determined globally – part 1
• Long term inflation
expectations are firmly on target
around th...
Source: Macrobond, ONS, Bloomberg, International Federation of Robotics
• The slowdown in UK real
earnings growth pre-date...
Source: Macrobond, Bloomberg
China is a big deflationary force for the world…
• Chinese export price inflation
explains a ...
Source: Macrobond, Bloomberg, Bank of England, Bank for International Settlements
…and it’s only going to continue as mone...
Source: IMF, Macrobond, Bloomberg
The global savings glut – it’s still there
• ‘Global imbalances’ matter.
The wall of sav...
Source: Financial Stability Board, Macrobond, Bloomberg
Quantitative easing is going to continue in Europe and Japan
• Cen...
Source: Macrobond, Bloomberg
Domestic reasons for low rates – part 1
1
1.5
2
2.5
3
3.5
4
4.5
1996 1998 2000 2002 2004 2006...
Source: Conference Board, Bank for International Settlements, Macrobond
• The UK’s productivity growth
following the crisi...
Source: Macrobond, Bloomberg, Office for Budget Responsibility
• There are substantial cuts in
public spending to come. Fo...
Domestic reasons for low rates – part 4
• The debt service ratio has
come down, and it’s likely that
this has helped pave ...
Follow us on Twitter
14
@RBS_Economics
https://twitter.com/rbs_economics
Or visit us online
15
Disclaimer
This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and
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Why UK interest rates could stay lower for longer than you think

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Markets expect the Bank of England to start raising rates from early next year. In 3 years Bank Rate is expected to be 1.5%. While possible, it is not inevitable. We’ve seen these sorts of expectations dashed before.

In the following slides, Marcus Wright sets out the economic case for ‘lower for longer’ interest rates in the UK.

‘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.

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Why UK interest rates could stay lower for longer than you think

  1. 1. Why UK interest rates could stay lower for longer than you think Marcus Wright RBS Economics November 2015
  2. 2. Slide 2Source: Bloomberg, Macrobond Of the OECD central banks that raised rates after 2008, all have either lowered or begun to lower them again 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
  3. 3. What this is about • Markets expect the Bank of England to start raising rates from early next year. In 3 years Bank Rate is expected to be 1.5%. While possible, it is not inevitable. We’ve seen these sorts of expectations dashed before. • The following slides set out the economic case for ‘lower for longer’ interest rates in the UK. • ‘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.
  4. 4. Source: BIS UK inflation is determined globally – part 1 • Long term inflation expectations are firmly on target around the world. This means less need for interest rate hikes, since inflation is currently low. • Things that drive price inflation are now more responsive to global factors. For example, earnings growth has become increasingly correlated across economies. 0 1 2 3 4 5 6 7 Inflation Expectations Against Target (%)Long-terminflation expectations Target CH JP EA CA CZ NZ GB SE US PL NO KR PE AU HU TH CN CL CO MX PH BR RU ID IN TR 0 10 20 30 40 50 60 1996-2000 2003-07 2010-14 Correlationof Cross-Country* Wage Growth (%) # - AU,CA,CZ,EA,HU,JP,KO,NO,PO,SA,SW,SZ,UK,US
  5. 5. Source: Macrobond, ONS, Bloomberg, International Federation of Robotics • The slowdown in UK real earnings growth pre-dates the financial crisis. •Net migration, outsourcing, offshoring and labour-saving technology have kept a lid on wage growth. • Capped wage growth reduces the likelihood of inflation picking up too fast or too far.0 50 100 150 200 250 300 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 15-'17 F-cast WorldwideSales of Industrial Robots (000s) UK inflation is determined globally – part 2
  6. 6. Source: Macrobond, Bloomberg China is a big deflationary 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
  7. 7. Source: Macrobond, Bloomberg, Bank of England, Bank for International Settlements …and it’s only going to continue as money continues to flow out •China’s banks are sitting on £10trn worth of deposits. As China liberalises its financial system these savings will flow out of the country in search of returns. • Capital outflows will put further pressure on the currency. If China lets its currency float it would make its exports cheaper and lead to even lower prices across the world. - 2 4 6 8 10 China UK Banking Sector Deposits (£ trn) Households and Non-Financial Corporates -30 -20 -10 0 10 20 30 40 China Brazil Russia India Poland Indonesia Mexico South Africa Malaysia EM Currencies - Under/Over-Valuation Estimate (Real Effective Exchange Rate) Increasingly 'under-valued' Increasingly 'over-valued'
  8. 8. Source: IMF, Macrobond, Bloomberg The global savings glut – it’s still there • ‘Global imbalances’ matter. The wall of savings moving from ‘surplus’ countries to ‘deficit’ countries is helping to keep interest rates low in the latter (e.g. the US and the UK). •And there’s more to come. Global savings are higher than before the crisis. Emerging Asia in particular and will have high savings in the coming years. 10 15 20 25 30 35 40 45 50 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 Savings Ratios (% of GDP) Global Global Forecast G7 G7 F-cast Emerging Asia Emerging Asia F-cast -1,000 -500 0 500 1,000 1,500 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Global Imbalances (Currenc Account Positions $Bn) Australia Spain UK US Japan Germany China Oil Producers
  9. 9. Source: Financial Stability Board, Macrobond, Bloomberg Quantitative easing is going to continue in Europe and Japan • Central banks are also keeping rates down by buying up government bonds (Quantitative Easing or QE). •While QE may have come to an end in the US and the UK, the European Central Bank will be carrying on until Autumn 2016, while the Bank of Japan’s programme is open-ended. 0 20 40 60 80 100 120 140 160 180 200 2009 2010 2011 2012 2013 2014 2015 Central bank purchases ($Bn) Fed Bank of England Bank of Japan Bank of Japan Forecast Purchases ECB ECB Foreast Purchases -2 -1 0 1 2 3 4 Banks Ins. Comps & Pens.Funds Public FIs Non-Bank FIs Centralbanks Change in share of financial assets 2007 - 2013 (percentage points)
  10. 10. Source: Macrobond, Bloomberg Domestic reasons for low rates – part 1 1 1.5 2 2.5 3 3.5 4 4.5 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 - 2015 UK Services Inflation - % Y/Y • Core inflation (which excludes food & fuel) has been decreasing for four years. And lower inflation is not just about oil prices and a stronger currency. • Services inflation has dropped well below the 3 – 4% it has averaged for close to 20 years. It is now averaging 2 – 3%. 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 UK Core Inflation (i.e. excluding food, energyand other volatile items) % Y/Y
  11. 11. Source: Conference Board, Bank for International Settlements, Macrobond • The UK’s productivity growth following the crisis has been exceptionally poor. There is no single explanation as to why, but the problem is deep-rooted. •Without productivity growth wage growth and economic growth could easily fizzle out. That means low inflation. And low interest rates. -6% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% Greece UK Finland Italy Belgium Netherlands Norway Cyprus Switzerland Germany Sweden Denmark Austria France Turkey Malta Iceland Luxembourg Portugal Spain Ireland Labour Productivity Growth 2008 - 2014 (Output per hour) Domestic reasons for low rates – part 2 -2 3 8 13 18 -2 3 8 13 18 UK - Wage Growth v Productivity Growth (% Y/Y Change) Nominal Wage Growth Productivity Growth
  12. 12. Source: Macrobond, Bloomberg, Office for Budget Responsibility • There are substantial cuts in public spending to come. For the government to attain a budget surplus it is likely that the private sector will have to start borrowing again. That is rarely sustainable for long. • It’s likely that for austerity to succeed without causing a recession, the Bank of England will have to keep rates low. Simultaneous fiscal and monetary policy tightening normally only achieves this when exports are growing strongly. And they aren’t. -4 -2 0 2 4 6 8 10 1997 2000 2003 2006 2009 2012 2015 2018 Private Sector Financial Balance in the UK (% of GDP) PNFCsForecast PNFCs Household Forecast Households Total Private Sector -12 -10 -8 -6 -4 -2 0 2 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 UK Budget Balance (% of GDP) Historical Data IMF Forecast OBR Forecast Domestic reasons for low rates – part 3
  13. 13. Domestic reasons for low rates – part 4 • The debt service ratio has come down, and it’s likely that this has helped pave the way for the recovery the UK has experienced in recent years. • But the UK economy remains encumbered by a large level of debt. • It will be difficult raising interest rates with the debt overhang remaining so sizeable. Source: BIS 0 50 100 150 200 250 300 2005 2007 2009 2011 2013 2015 UK Debt to GDP (%)Government Households Non-Financial Corporates -10 -5 0 5 10 Den Spa UK Hun Por SA US Aus Jap Ger Ita Kor Cze Pol Mex Swe Bel India Fra Indon Bra Neth Thai Mal Tur Rus HKSAR Chi Debt Service Ratios - Change since 2008, Private Non-Fin Sector
  14. 14. Follow us on Twitter 14 @RBS_Economics https://twitter.com/rbs_economics Or visit us online
  15. 15. 15 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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Markets expect the Bank of England to start raising rates from early next year. In 3 years Bank Rate is expected to be 1.5%. While possible, it is not inevitable. We’ve seen these sorts of expectations dashed before. In the following slides, Marcus Wright sets out the economic case for ‘lower for longer’ interest rates in the UK. ‘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.

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