In the past few weeks two of the main central bankers that financial markets monitor closely, namely the Federal Reserve’s Janet Yellen and Bank of England’s Mark Carney, have become more vocal about the increased chances of higher interest rates. Following years of monetary easing with interest rates slashed to record lows across most developed economies and quantitative easing programs that have seen unfathomable sums of new money printed, we are now very close to seeing the purse strings being tightened. Many are asking why interest rates have remained so low for so long, especially retirees who before the financial crisis seven years ago, enjoyed rates of interest that they could rely on as steady source of income to fund their retirement. The problem for risk adverse income and yield seekers is that when the rate rises do commence, they will be very gradual and are not expected to peak anywhere near as high as the five or six percents we used to see prior to 2007.
So why are Mrs Yellen and Mr Carney becoming so vocal about putting their fingers on the trigger and have the US and UK economies recovered to a robust enough position to warrant the commencement of monetary tightening? After all, inflation remains very low on both sides of the Atlantic and average earnings are rising, but not at break neck speed. One of the major issues they face is that this environment of ultra-low interest rates cannot last forever and there has to be normalisation soon before the situation of resource misallocation becomes a real problem. A good example of this is the housing markets in both the US and UK. In the US house prices have been accelerating and are not far off their peak before the 2007/08 financial crisis. Meanwhile mortgage rates are near their all time lows and the Fed is concerned that without normalising its base rate soon, there will be a similar bubble to the one that was created only a few years ago.
In the UK any first time buyer will tell you that prices are crazy and for many totally unaffordable, yet despite the measures already taken by the Bank of England to toughen up mortgage lending criteria in a bid to take the sting out of house prices, which it succeeded in doing to some degree last year and in the run up to the General Election, the demand and supply dynamics in the UK mean that the upward pressure to prices remains. The worry for a great deal of home owners with mortgages is of course that rate rises mean more money that has to be paid to the bank and that means less disposable income, which for an economy that is so heavily reliant on the consumer, will adversely affect UK growth. But at least the rate rises for the vast majority should be affordable as according to the global credit ratings and research agency Moody’s, UK home owners are in a good position to weather rate hikes as they estimate around only one percent of borrowers would not be able to make their mortgage payments if the Bank of England hiked rates by one percent.
There is no question though that both economies have labour markets that are in good shape. The US for example has experienced its longest monthly run of growing payrolls since the Second World War and this should continue even as rates rise. The UK’s strong labour market is playing through to consumer confidence and only recently a CEBR and YouGov survey showed British shoppers are more confident than they’ve been since September, meanwhile the GfK measure of consumer confidence remains firmly in positive territory and has done so throughout 2015.
So no matter how much businesses and consumers do not want to see the commencement of monetary tightening, we have to accept a normalisation is around the corner. At least with this much advanced warning, those that will be most affected need to prepare themselves now and will not be able to say they didn’t see it coming.
Legal: The information in this article is not directed at residents of the United States, or targeted at the general public of any particular country. It is not intended for distribution to, or use by, residents in any country where such distribution or use would contravene any local law, or regulatory requirement. This marketing material should not be construed as a personal recommendation or as investment advice. Any opinions made may be personal to the author and may not reflect the opinions of FxPro.
Risk Warning: Transactions in Contracts for Difference and Foreign Currency are leveraged products that can result in the loss of all your invested capital. These products may not be suitable for everyone. Please seek advice if you do not fully understand the risks. You should not risk more than you are prepared to lose. Before deciding to trade, please ensure you understand the risk involved and take into account your level of knowledge and experience. Seek independent advice if necessary.