World Economy

Yellen, Carney Hint at Rate Rises

Yellen, Carney Hint at Rate RisesYellen, Carney Hint at Rate Rises

Since the start of the year investors have wondered whether any of the world’s largest central banks will finally begin to break with the ultra-low interest rates that have dominated monetary policy since the financial crisis.

This month Janet Yellen, US Federal Reserve chair, and Mark Carney, her counterpart at the Bank of England, made clear that a rupture was fast approaching.

An increase in borrowing costs in the US and Britain will see monetary conditions in those two economies diverge from the eurozone, Japan and China, where central banks remain in easing mode, NewsNow reported.

It will also have consequences for emerging markets, many of which used the space afforded by falling oil prices and global inflation to slash interest rates, but now face the risk of capital flight, which may force them to reverse gear.

In her testimony to Congress, Yellen said the Fed was on course to raise borrowing costs this year, provided the economy behaved as expected. A day later, Carney indicated that the BoE was not far behind.

“The decision as to when to [raise rates] will probably come into sharper relief around the turn of this year,” the BoE governor said in a speech at Lincoln Cathedral.

Investors appear to have heeded the two central bankers, and are pricing in a first rate rise in the US by December, with the Bank of England moving in February.

But for all the market confidence, and the stepping up of central bankers’ rhetoric, three issues will decide how policymakers act:

1. International Environment: While both the Fed and the BoE have a purely domestic mandate, they look after economies that are buffeted by the wider world.

Several members of the BoE’s Monetary Policy Committee held back from voting for a rate rise in July because of the stand-off between Greece and its creditors, which risked pushing Athens out of the euro. Minutes from June’s Federal Open Market Committee meeting also noted that global risks, including the Greek crisis and China’s slowdown, were giving some rate-setters cause for concern.

2. Currencies: A bigger concern has to do with the rise of the dollar and the pound, which have increased markedly against the euro as investors price in forthcoming rate divergence.

3. Inflation and Growth: Ultimately, central bankers will decide on the basis of their bread-and-butter metrics: inflation and the strength of the recovery. The real dilemma they face is deciding on the balance between the two objectives.

Economists suggest that, at the moment, headline inflation figures are a poor indicator of underlying price pressures: the steep fall in oil prices that occurred in the second half of last year caused a one-off drop in inflation that will evaporate from the yearly comparison as we move into the autumn.