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US vs UK
16 Jul

Who Blinks First? The BoE Or The Fed?

US vs UK

Governor Mark Carney of the Bank of England announced his intention to raise the central bank’s interest rates for the first since the 2008 crisis.

As rates are currently practically to the floor and as the economy picks up in the UK, the BoE governor believes the time is ripe for an interest rates’ hike.  Yet, it was unclear whether the move would come after or before a similar hike by the Fed. Traditionally, despite the BoE’s best assurances that it isn’t the case, the Fed has always taken the lead in terms of interest rates fluctuations since the 1970’s. Janet Yellen confirmed that the Fed would proceed with the rate hike but all bets are off as to which institution will make the first step this time.

Usually, rate hikes come in at times of economic growth. While this is the case in both the UK and the US strictly speaking, the current economic recovery in both countries is rather flimsy at best. GDP growth in the UK in the 4thQ 2014 was a mere 0.5% while in the US, GDP growth hit 2.2%. However, the picture is reversed for the 1stQ 2015 where the US economy contracted by -0.2% and where the UK held on to a similar growth rate of 0.4%. We therefore are not talking about a strong recovery here, reason why both central banks have been so reluctant to raise their interests rates over fears that they could harm or even stall the recovery.

However, it seems as if history is bound to repeat itself as Janet Yellen confirmed that the Fed was on the course of raising their interest rates. If the Fed did, there is little doubt that the BoE would do so too shortly thereafter. The question on everybody’s lips, however, is which will go first and why would the UK resort to an interest rate hike while deflation looms over the British economy? The American case is even less sensible as the country has been in deflation since the beginning of the year.

One explanation of course is the political pressure on both sides of the Atlantic to stop the supply of “cheap money” to the market and to start to rely more on economic fundamentals to grow the economy again. As laudable a policy this may be, the timing is certainly unsuitable. This concern was echoed by the IMF, which expressed reservations about the Fed’s proposed hike and suggested instead that any hike should be postponed until 2016 at least. The very idea that both the American and British economies would lose their momentum and slide back into recession because of interest rates adds to ongoing threats emanating from such places as China, Greece and Puerto Rico. While these economic woes are not all interrelated, they add a tremendous lot of uncertainty for the markets.

The question should therefore be: are the BoE or the Fed going to raise their interest rates at all? They know they want and have to, but it would be unrealistic at this stage.

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