Prospects still slim for major global economic pickup

23 Dec 2015 | Author: | No comments yet »

Fed hike clears path for Bank of England, but not right away.

And given the Fed’s promise of a gradual path ahead, the real test will not come until later next year when its forecasts are tested. “Generally if you’re in an interest rate tightening cycle, it’s because you’ve got better economic conditions,” says fund manager Darren Thompson from Northward Capital who holds stocks such as Brambles and James Hardie, both of which are linked to the US economy. “We think overall they’re good businesses at decent valuations, but also the environment is robust enough to support their business and help them grow.” In domestic equities, expectations were reset after the correction in August. 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. 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. The latest signals from the Bank of England’s Monetary Policy Committee (MPC) have indicated that we should not expect a rate rise in the near future.

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. Recent statements from Mark Carney and his deputy, Minouche Shafik, have reinforced the view that the UK will not be in a hurry to follow the lead of the US Fed. We know this because the Fed, unlike the Reserve Bank of Australia, issues forecasts for the targeted level of interest rates years in advance based on its internal survey. The latest Reuters poll of economists indicated that the first UK interest rate rise would take place in the second quarter of 2016 (April to June) – so could be only a few months away.

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. The median forecast by Fed participants is for a Fed funds rate of 1.375 per cent by December 2016 but traders are only seeing rates rise to 0.835 per cent. “An early Fed tightening cycle – apart from 1994 – needn’t kill the equity bull market, it’s only in the latter stages when inflation is picking up,” says David Bassanese, chief economist at Betashares Capital. 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. That’s because corporate earnings benefit from the early stages of a cyclical upswing while borrowing costs are still low. “The Fed is like a double-edged sword – on the one hand it’s raising interest rates which adds some risk because it pressures valuations in the equity market and the US housing market.

But it also helps reload the cannon in the sense that if you think the economy is good, it gives them scope to respond to another crisis down the track. “Unlike our central bank, they seem to feel less compulsion to worry about potential asset price bubbles. If the RBA was running the US Federal Reserve and Glenn Stevens was the Fed chair, he would have tightened two years ago.” Some pockets of the market were already looking vulnerable ahead of the Fed decision.

Growth and inflation in both the UK and US are also projected at similar rates, with GDP rising by between 2pc and 2.5pc and inflation moving back up to 2pc as the impact of lower oil prices drops out of the calculation. France continues to be a drag on European growth, but this is offset by better performance in other countries in northern Europe, such as Poland and Sweden.

And there are signs that these are feeding through into wage increases – for example, pay rates are now increasing by over 6pc in the construction sector. So UK borrowers and savers should keep a close eye on monetary policy on the other side of the Atlantic if they want to know what is going to happen here.

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