A quite expected development

Tony Ward

December 18, 2015

Tony Ward is chief executive of Clayton Euro Risk

So it has come to pass that the Federal Reserve has finally made its decision to raise interest rates for the first time in nearly a decade. Unsurprisingly, the markets responded positively, rising sharply after the Fed abandoned its zero-rate policy and increased the federal funds rates by one-quarter per cent to a range of 0.25%–0.5%. The rate rise vote was unanimous, with the announcement coming as a relief to the markets as it removes uncertainty. Investec’s Philip Shaw said the decision had ended the period of policy emergency and ushered in ‘a gradual normalisation’.

This move was not unexpected: back in August, I predicted there would be a US rate hike this year. So what now? Attention will focus on the trajectory of future rates rises, which Janet Yellen, chairwoman of the US Federal Reserve, has suggested will be slow and lengthy. In its statement, the Fed reiterated it expected gradual increases in the Fed funds rate going forward.

What does this means for the UK and how it will influence the Bank of England? In a previous blog I suggested that it would be an error for Mark Carney to act impulsively and raise rates with so many unknowns in the pipeline. Inflation remains stubbornly low: while some commentators argue prices will bounce back strongly I can’t see that happening in the near future while there is still much ambiguity around the price of oil. Brent Crude has fallen again and as John Hall, veteran oil analyst at Alfa Energy, said: “There is nothing left to restrain prices. Petrol prices are likely to keep falling .”
In addition, the rate of wage growth seems to have leveled off. The Office of National Statistics reported that workers’ pay grew at its slowest rate since January–March. Total pay grew 2.4%. ‘Earnings continue to grow in real terms, although at a slower rate than we have seen in recent months,’ ONS statistician David Freeman reported. Bank of England Governor Mark Carney has said he would like to see earnings growth above 3% a year before he would increase interest rates. Mr Carney has signalled that he is in no hurry to lift rates and they will remain ‘low for long’.

Carney’s view was supported by the Bank’s deputy governor Minouche Shafik, who commented: “I will wait until I am convinced that wage growth will be sustained at a level consistent with inflation returning to target before voting for an increase in Bank rate.” That’s a clear signal then.

Whether the majority of members of the Monetary Policy Committee agree with these views remains to be seen, but I believe there should be no rush to follow the decision made by our friends across the pond.

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