Western Economies Too Weak For Short-Term Rate Rise
Interest rates are going up! Or are they? Is the era of ultra-cheap money, on both sides of the Atlantic, about to end? Or is this renewed bout of rate-rise speculation another false alarm?
Janet Yellen, who chairs the mighty Federal Reserve, is clearly signaling a rise in US interest rates soon – a move the Bank of England would probably follow. “Prospects are favorable for further improvement in the US labor market and economy more broadly,” Yellen boomed last Wednesday.
“If the economy evolves as we expect, conditions would likely make it appropriate at some point this year to raise the federal funds target rate,” she told a congressional committee.
Since the Lehman Brothers collapse, and ensuing global financial crisis, Western central banks have kept interest rates, for the most part, nailed to the floor. The Federal Reserve’s main rate has been practically zero since late-2008, with the Bank of England’s base rate at 0.5pc since March 2009 – as we’ve struggled to recover from the most serious peace-time slump since the 1930s. Rates this low, for this long, are simply unprecedented.
Now, though, the Federal Reserve is striking a far more positive tone. Yellen last week pointed to a “great deal” of economic improvement since the post-Lehman trough, not least the creation of 12m American jobs. Despite Greek riots, European diplomatic turmoil and plunging Chinese stocks, she focused on the nascent US upturn. “Households have both the wherewithal and the confidence to purchase big-ticket items”, said Yellen, highlighting strong auto sales over recent months. With industrial output 0.3pc higher in June, and producer price inflation up for the second successive month, the Federal Reserve predicted US growth of 2.5-3.0pc during the second and third quarters of 2015.
Yellen wants rates to rise soon and relatively slowly, she explained, rather than delaying – which risks bring sharper, more frequent rises. “If we wait longer, it could mean that when we begin we have to raise rates more rapidly,” she said. “An advantage to beginning a little bit earlier is that we might have a more gradual path of rate increases”.
As the dollar rose on these words, polls of Wall Street economists converged on the view that America’s six-year zero-interest-rate-policy will end when the Fed meets in September – in just nine weeks’ time. Sentiment in the City of London shifted, also. While most analysts had been predicting a mid-2016 rate rise, there was suddenly much excited chatter an increase could happen before the end of 2015.
Mark Carney himself then weighed in, giving a speech on Thursday night as clear and punchy as that of Yellen. The decision to raise UK rates will likely come into “sharper relief” by “the turn of this year”, the Bank of England Governor observed, in his strongest signal yet that policymakers are preparing to act.
The British economy grew 2.9pc year-on-year during the first quarter of 2015. Official estimates point to a buoyant 2.5pc expansion for the year as a whole. News that real wages rose 3.2pc during the three months to May, the fastest rise since April 2010, adds to the notion that the time for emergency ultra-low interest rates is coming an end. David Miles, an outgoing member of the Bank of England’s Monetary Policy Committee, said it would be “a bad mistake” to keep waiting before raising, reinforcing that sense that the UK, too, will soon see rate rises.
I think interest rates in both America and the UK should go up soon. They should, in fact, have been raised some time ago. Western financial markets, both bonds and equities, are massively hyped-up, distorted by too-low-for-too-long rates that have left asset prices subject to dramatic, confidence-sapping corrections.
Artificially cheap borrowing costs have, for several years now, encouraged Western governments to keep piling debts onto their national balance sheets, even in nations such as the UK which talk a lot about “austerity”. They’ve also encouraged the existence of numerous “zombie” companies, kept alive only by artificially cheap money. Widespread “mal-investment” in such outfits is, in my view, a key explanation of low UK productivity.
Flat nominal interest rates, in addition, given on-going inflation, become negative in real terms – penalizing savers and creditors. That means less money for pensioners on fixed-incomes and those approaching retirement – so a fast-expanding part of the population spends less. That’s the opposite of the economic boost low interest rates are meant to provide.
Despite this latest missive from Yellen, though, and coordinated corroboration from Carney, I doubt that rates in either the US or UK will rise anytime soon. For one thing, our respective recoveries are too weak. The US economy contracted during the first quarter and, despite Yellen’s bravado, retail sales fell in June. UK growth, also, is still heavily dependent on cheap credit.
Policymakers want to convey an air of normality, and assert recovery is taking hold, but the world economy remains awash with systemic dangers, any one of which could shatter what recovery we have achieved. Such a reversal, or even fears it could happen, will likely mean rate rises keep getting delayed.
Despite much euphoria at last week’s “deal”, the situation in Greece is still desperate. While officialdom stands ready to hose down European bond markets with printed money, which partly explains their relatively calm, the political argy-bargy won’t get a lot worse before it gets better. That’s especially true now the International Monetary Fund has asserted (via a carefully-timed leak, no doubt at the behest of a US administration entirely sick of the Eurozone’s antics) that Germany and the EU’s other large economies must finally temper this crisis by granting Athens even more debt relief – and on a massive “once and for all” scale.
That could well spark popular protests not only in bail-out-sweated nations such as Spain and Portugal but also France – where displays of German dominance, followed by an eventual sweet-heart deal for Greece, can only bolster fast-growing eurosceptism. Western Europe, with its powder-keg currency union, and moribund banking sector, sporting over a trillion euros of non-performing loans, remains in grave danger of a systemic lurch. Policymakers everywhere know it – and until there are definite signs of calm, which may not happen until at least one eurozone member leaves, rates will likely stay put.
China, too, poses major dangers, its own stock market bloated – having ballooned 150pc in a year, before crashing by 30pc in recent weeks. The emerging markets in general, while subject to QE-fuelled hubris of their own, are probably even more vulnerable to policies emanating from the Fed.
In 2013, when Yellen’s predecessor Ben Bernanke last tried to “normalize” US monetary policy, he was forced to retreat – as the threat of a higher dollar caused chaos on foreign exchange and debt markets, not least in the big emerging economies.
Back then, a so-called “taper tantrum” reflected fears a spiraling US currency would cripple nations with large dollar-denominated debts. As their currencies fell, investors worried imported inflation would cause an interest rate spike across the emerging markets, stymying growth there too. Given such nations’ importance to global growth, the risk was too great, and Fed rate rises were further delayed – a scenario that could easily be re-run.
I’ve no idea when US, and therefore UK interest rates, will rise. No-one does – not even the central bankers. But, in my view, the Western recovery is too weak, and the danger of a eurozone meltdown or emerging market reversal is still too acute, to allow a rate rise any time soon. And I say that with regret.
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LIAM HALLIGAN 