This year's slowdown in emerging markets has forced central banks in the West to re-think their plans for raising interest rates.
The US Federal Reserve was widely expected to increase interest rates this summer. The Fed had hinted that a rate rise was likely and US growth seemed strong enough to withstand a first step towards normalising monetary policy. In the event concern over the downturn in emerging markets, especially China, and a global sell-off in equities, meant that the Fed kept rates on hold.
Now, the Fed is talking up the chance of a rate rise. In congressional testimony earlier this month Fed Chair Janet Yellen said that a December rate hike is a "live possibility".
What has changed since the summer?
Equity markets have stabilised after the turmoil in August and the slowdown in China seems less likely to turn into a rout. But the biggest change has been in the US labour market. US employment growth has been strong, with the unemployment rate at a seven-and-a-half-year low and wages showing good growth. More jobs and rising wages are supporting consumer spending. With domestic data looking up the Fed has become more confident about America's ability to weather weakness overseas.
Underlying inflation pressures are stronger in the US than in Europe, further strengthening the case for a rate hike. While so-called headline inflation remains flat, core inflation – which strips out the effects of volatile food and energy prices – is at 1.8%, not far off the Fed's 2.0% target. Inflation expectations have also risen, with many economists expecting headline inflation to rise from around zero today to 1.5% next year.
A December rate rise looks increasingly likely for the US. A survey of economists by the Wall Street Journal last week showed 92% expected the Fed to raise rates at their meeting on 16th December. If the Fed does raise rates next month it will be a momentous event, the first increase in US interest rates in almost 10 years. As the New York Times noted last week, "The last time the Fed raised interest rates, in June 2006, Facebook was mainly for college students and had one-tenth the users of Myspace".
The timetable for UK rate rises is running almost a year behind the US. In July the Bank's Governor, Mark Carney, suggested that the Bank would raise rates around the turn of this year. Like the Fed, weakness in emerging markets has made the Bank push back the timing of rate rises.
In launching the Bank of England's November Inflation Report Mr Carney described the UK economy as "robust" and "resilient". But the Report struck a markedly doveish tone by playing up concerns about the effect of global weakness on UK growth and inflation.
Moreover, in contrast to the US, core inflation in the UK is weak and market expectations for inflation expectations are low. Markets now expect the first UK rate rise to come towards the end of 2016.
Far from contemplating rate rises, the European Central Bank seems to be moving towards a further easing of monetary policy. Euro area growth is sluggish and headline and core rates of inflation are low. Our latest European CFO Survey, released today, confirms that weakness in the global economy has knocked business confidence across Europe. In most countries corporate risk appetite has fallen back and Chief Financial Officers are focusing on cutting costs. To read the full report, please visit:
http://www.deloitteresearchemea.com
Financial markets expect the ECB to expand its programme of quantitative easing or lower interest rates in December.
America seems likely to lead the charge on raising interest rates, with the UK following perhaps towards the end of next year. Markets are assuming no rise in European interest rates for at least the next two years.
Such views need to be treated with caution. Market expectations for interest rates, like the opinions of central bankers, are changeable. Whatever central banks say today about what they plan to do in the future depends on data panning out as expected – something which often doesn't happen.
What is clear is that central banks do not expect to raise rates rapidly. On the contrary, the Fed and the Bank of England have signalled that rate rises, when they come, will be gradual and cautious. Western interest rates seem likely to remain below pre-crisis levels for years to come.
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