Who will raise rates first: Yellen or Carney?
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There have been some epic transatlantic yacht races over the decades. It is always a contest of navigation, strength and skill, which pits each sailor against both the elements and the competition.
But right now there is another transatlantic race underway, and this one is being fought among central bankers. Which country will raise interest rates first, Britain or the United States? Both Bank of England Gov. Mark Carney and Federal Reserve Chairman Janet Yellen have been making increasingly aggressive noises about bringing to an end five years of super-cheap money.
But who will move first? For three reasons, the smart money should be on the U.S. The U.K. will inevitably be caught up in the depression that is locked into the euro zone. It is entering eight months of political instability. And its recovery is far less firmly rooted. No central banker is going to want to be the first to raise rates — they don’t want the blame for choking of a recovery that still looks dangerously fragile.
But if anyone is going to do it, it will be Yellen and not Carney.
The speculation in the markets is all about when central banks will bring to a close more than five years of super-cheap money that started with the financial crash of 2008, and begin raising interest rates. But one thing is abundantly clear. This is a race with only two horses in it.
The Bank of Japan is not going to raise rates any time soon. Abenomics is still in its early stages, and if anything the bank is more likely to start printing yen again than push interest rates up. The European Central Bank? Forget it. The euro zone is sliding rapidly into deflation, and growth has ground to a halt. The only move it is going to make right now is launching its own version of quantitative easing — a rate hike is about as likely as the French President Francois Hollande introducing a flat tax.
True, some very minor central banks may move earlier. New Zealand has already raised its interest rates. There has been some speculation that Australia might follow its lead, although it has not done so yet. Sweden and Norway might make a move, although the Swedes will be chastened by the rate rise earlier in the cycle that had to be reversed.
But, with no disrespect, no one much cares what happens in New Zealand or Norway. The interest rate move that matters will come from one of the major economies.
Who goes first is important. For the last five years, the global economy has been in uncharted territory. With the exception of Japan, interest rates had never been this low before. What happens when you start to raise them from these levels? Do the markets take it in their stride? Or do they keel over and die?
It is like being the test pilot on a new, experimental plane — the wind tunnels and computer simulations might say it is safe, but until someone takes it up into the air, no one knows for sure. Whatever the economic models might predict, until rates go up, you can’t know the consequences. It is much better if someone else goes first — and gives you the chance to learn from their experience.
So which will it be — the U.S. or the U.K.? Both countries seem to be moving beyond the point where rates need to be held at emergency levels.
The IMF predicts that the British economy will expand by 3.2% this year. Unemployment is falling at a decent rate, and house prices are rising strongly. Inflation is subdued. True, real wages are still very weak. Even so, it is hard to see the emergency. By any historic standards, the economy is doing perfectly well. Certainly no one would be cutting rates against that backdrop.
Much the same is true in the U.S. The economy expanded by 4% in the second quarter of the year. True, that might not be sustained. But the IMF predicts 2% growth this year, and above 3% next. Employment is performing respectably. Jobs are being created, and while wage growth is muted, debts are falling, and property prices are recovering. There have been plenty of stronger spells of U.S. growth.
But, much like the U.K., it is hard to see it as an emergency anymore.
But it is Carney who faces the more formidable obstacles. Even though two members of the Monetary Policy Committee have already voted for a rate rise, there are three factors that are going to delay that decision.
First, the U.K. is heading into a period of political instability. Next month, Scotland will vote on whether to become an independent country. If it does, sterling GBPUSD, +0.20% will be plunged into chaos, as the two countries try to disentangle their finances. In May next year there will be a general election, and with the polls neck and neck that may produce a very close result, and another coalition government. A rate rise will only make an unstable situation worse.
Next, the U.K. is going to get hit by the depression in the euro zone. In total, 18% of the U.K. economy is made up of exports to Europe. With even Germany grinding to a halt, that fifth of the economy is going to struggle, dragging down the rest.
Finally, its recovery is less firmly rooted. It may be growing faster than the U.S. right now, but that has been buoyed . by rapid house price inflation, and continuing immigration. Gross domestic product per capita is not growing at all, and house prices can’t keep going up forever. There is a lot of froth — and that can get blown away very easily.
Rates will have to rise sometime — and it will be a tremendous gamble when it happens. Right now, it looks as if it will be Janet Yellen who will have to make that move — and it will be her reputation that will be on the line.
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