Bank of England Treads Fine Line on Interest Rates

23 Dec 2015 | Author: | No comments yet »

Bank of England Treads Fine Line on Interest Rates.

LONDON (Reuters) – The first U.S. interest rate rise in nearly a decade helps clear the way for a similar, long-anticipated move by the Bank of England.

Traders are fully pricing in a rate increase of 25 basis points from the BOE in February 2017, according to forward contracts based on the sterling overnight index average, or Sonia.Even after Federal Reserve Chair Janet Yellen and colleagues raised the target range for the federal funds rate to 0.25 percent to 0.5 percent, that’s still way below its 2 percent average since 2000 and the 3.2 percent of 2000 to 2007. But a key question for rate-setters here is whether British households, still scarred by the financial crisis and laboring under heavy debts, will be ready to cope with higher borrowing costs.

It also means JPMorgan Chase & Co.’s average rate for eight developed nations and the euro-area weighted by size is on course to end 2016 at just 0.36 percent. British central-bank officials have for months signaled that the time to raise their benchmark interest rate from its historic low of 0.5% is slowly drawing nearer. The UK Office for National Statistics said regular earnings of workers — excluding bonuses — rose 2% in the three months to October, its slowest since the three months to February.

Crucially for Carney, it allows him to assess how the U.S. economy and markets react to costlier borrowing before making what will be a sensitive move of his own. In the past 20 years, the BOE has tended to follow its U.S. counterpart with a lag of about three months, according to economists at Deutsche Bank AG. The slowdown contrasted with strong job creation and a surprise fall in Britain’s unemployment rate and added to the mixed signals coming from the labour market that have puzzled Bank of England governor Mark Carney and his fellow policymakers.

If the Fed lifts its benchmark to 1.5 percent a year from now, as JPMorgan predicts, the bank’s economists still see the rate for the key industrial economies undershooting 1 percent next December as the European Central Bank and Bank of Japan stay on hold. The British economy is likely to be among the world’s fastest-growing for a third year in a row next year and, just as in the United States, it has seen a drop in unemployment. The lack of a pickup in speculation about a U.K. rate increase was reflected in the nation’s government bonds, which rose Thursday. “With the U.K. it’s a question of wait and see, and it’s still highly debatable as to when they’re going to make that move,” said Orlando Green, a fixed-income strategist at Credit Agricole SA’s corporate and investment-banking unit in London. In Ireland, Investec Ireland chief economist Philip O’Sullivan said after the crisis here that average weekly earnings, led by the private sector, have risen at a year-on-year rate of 2.7%. Reporting differences make a direct comparison with the U.K. difficult, but the U.S. index showed that inflation was unchanged in November on a seasonally adjusted basis and up 0.5 percent over the last 12 months before seasonal adjustment.

But faced with near non-existent inflation, sluggish wage growth and ultra-loose monetary policy in Britain’s main euro zone trading partners, Carney has already stressed he would not necessarily move in step with his Fed counterpart Janet Yellen. To be sure, he sent signals in July that a decision on whether to raise rates for the first time since 2007 could become clearer around the end of this year. They’ll remain supported for the time being.” The pound tumbled 0.9 percent to $1.4869 as of 4:20 p.m. in London, its biggest decline in six weeks, and dropped as low as $1.4865, its weakest level since April. The 0.5 percent rate has been maintained since a succession of interest rate cuts between December 2007 and March 2009, during and following the global financial crisis.

U.K. households are the second most-indebted in the Group of Seven advanced economies, with debts equivalent to 156% of their combined annual income, according to the Organization for Economic Cooperation and Development. While as recently as 2014 markets were forecasting the BOE would raise before the Fed, U.K. policy makers have signaled they’re in no rush to follow their U.S. counterparts. But as his predecessor Mervyn King – who was criticised for responding too slowly to the 2007-9 crisis – found out, the exact timing of any move is a delicate balancing act.

Carney’s previous hints of a British rate rise have been knocked off course by the twists and turns of the world economy, including the plunge in global oil prices which at one point sent British inflation tumbling to below zero. Britons owe more than £1.2 trillion ($1.8 trillion) in mortgage debt, and many homeowners are acutely sensitive to shifts in BOE policy due to the predominance of adjustable-rate mortgages.

Thereafter, that drag dissipates and, conditioned on the market path, building domestic cost pressures are projected to take CPI inflation back to the 2 percent target in the second half of 2017 and above it in 2018,” the report said. Minouche Shafik, the BOE’s deputy governor for markets and banking, said this week that rates probably will rise more quickly than the market currently implies. However, a long-term appreciation in the U.S. dollar in response to the Fed hike could create inflationary pressure in the U.K., potentially bringing forward the timing of a BoE rise.

By contrast, officials at the British central bank have in recent months limited themselves to saying they are watching and waiting to see how the country’s economy performs in the coming months, distancing themselves from clearer signals they sent previously that a rate hike might be coming. Grace Crawford, a 42-year-old local government worker from Hertfordshire in England, said she had only recently got her finances under control, thanks to help from Christians Against Poverty, a debt charity. In general, higher domestic interest rates increase the value of a country’s currency, as it become more attractive to foreign investors looking for returns. She added that she hadn’t had a pay raise in several years and that an increase in interest rates would make her regular mortgage repayments harder to afford. Giving British exporters some respite, sterling has fallen around 0.6 percent against the dollar since Dec. 1 as expectations for a U.S. rate hike mounted.

If BOE officials ratchet up interest rates too quickly, households may slash spending, imperiling the central bank’s goal of returning inflation to its 2% target. Andrew Sentance, a former member of the BoE’s Monetary Policy Setting Committee (MPC), said that the U.K. would hike rates sooner than markets expected and that the U.K.’s economy had recovered to roughly the same extent as the U.S. “There is no iron link between U.S. and U.K. interest rates, but if you look at the macroeconomic performance of the two economies, it’s been remarkably similar. We have had roughly similar growth rates over the recovery; the recovery started at about the same time; it has been going on about the same time; unemployment has come down to just over 5 percent and inflation in both countries is expected to drift back up to target once the oil price factors drop out.

Economists say that among borrowers who will be most vulnerable when rates rise are low-wage earners, who also face the prospect of planned cuts to benefit payments for working families. Also among those particularly exposed are so-called mortgage prisoners, who own a home but can’t easily refinance because of their age, poor credit scores, or because their house hasn’t recovered its precrisis value. For the BOE, the current period of low inflation offers a breathing space that officials hope will allow households to get in better financial shape before interest rates need to rise. Rob Jones, a 35-year-old teacher from London, said “it wouldn’t be great” for him if the BOE raised rates, as his two-year fixed-rate mortgage will soon move onto a variable rate and he already has to stretch to pay the current loan installments on his salary. “I wouldn’t be happy, but I think I would be able to cope to some degree,” he said.

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