And UK is bound to follow ... but not yet
AFTeR almost a decade of super-low interest rates, the Federal Reserve, America’s central bank, has finally drawn a line under the financial crisis that brought the world economy to a shuddering halt and ushered in years of falling living standards.
The 0.25 percentage point rise in US interest rates to a range of 0.25 to 0.5 per cent may not seem very decisive.
But the impact will be felt on financial markets around the world as this rise in borrowing costs will be seen as the first of many as America signals that it is time to ‘normalise’ interest rates, which have been held deliberately low to encourage a global economic recovery. The shock of the hike will, however, be eased by the promise by the Washington-based bank that future rises will be gradual and take note of international conditions.
The rate rise, unveiled last night by the Federal Reserve’s first female chairman, Janet Yellen, had an immediate impact on the foreign exchange market, with the pound falling against the dollar. This will make it more expensive for British holidaymakers heading to the United States for the holiday season. It will be better for British exporters hoping to sell their products and services in North America.
There is not likely to be any reaction by the Bank of england for the moment.
However, with British employment levels at the highest level in our history and the jobless rate down to 5.2 per cent of the workforce, a rise in the UK rate will come sharply into focus in 2016.
History shows that of all the major advanced nations, British interest rates most closely shadow those of the US, partly because of the strong financial and trade inter- connections between the City of London and Wall Street.
The jump in American rates could potentially have an early impact on mortgage deals available to British borrowers. Mortgage interest rates are largely set by conditions in the wholesale money markets, where banks lend to each other. These rates are certain to start rising in anticipation of the Bank of england’s first move.
It could also signal that after a long barren period, savings and deposit rates could finally start to offer better returns for the thrifty.
Technically, a rise in American interest rates would normally signal an increase in the value of the dollar against the pound and other currencies as capital flows from low interest rate areas, such as the eurozone and some developing countries, into New York. However, Mrs Yellen and her colleagues on the rate- setting Federal Open Markets Committee meticulously prepared traders and policy-makers for last night’s historic move in the brave hope of calming markets.
NeveRTHeLeSS, the move comes at a tricky time for Wall Street and the world economy. The past week has seen the embarrassing collapse of an American hedge fund, Third Avenue Management’s Focused Credit Fund, providing echoes of the failure of two funds run by the investment bank Bear Stearns on the eve of the 20072009 financial crisis.
It also comes against deteriorating global conditions partly caused by the slowdown in China and the precipitate fall in oil prices. Several natural resourcebased nations, including Brazil, South Africa, Canada and Australia, have moved into recession or are close to it.
The eurozone has negative interest rates and is still printing money on a monthly basis, as it seeks to pull out of stagnation. That places it on a collision course with American policy.
Markets were partly reassured last night by the Fed’s promise to keep its eye on global conditions, as well as inflation and strong employment in the US, before instigating the next rise.
But the die has been cast and the likelihood is that the US, followed by Britain, has embarked on a journey that could carry interest rates up to 2.5 to 3 per cent over the next several years.