Where next for interest rates?
Will we see further divergence in monetary policy across the world this year? Starting with the US, the Fed’s dots tell us that rates in could go up by 25 basis points each quarter in 2016. This is more than what the markets currently think, and Constance Hunter, our own US Chief Economist, believes rates are more likely to rise two or three times this year. So on current trajectory, US Fed rate may reach 1.5% by September 2017.
However for all of you action lovers 2016 may prove a little disappointing, as not many other major central banks are likely to follow the Fed this year. The Bank of England is the most prominent central bank that could start tightening this year, despite the recent dovish statements. With expectations of a further modest fall in unemployment and a rise in wages providing support to any rate decision this year, we could see a first rate rise before the summer, once the Brexit referendum is out of the way (and assuming an economy friendly resolution!). After that, we could see interest rates rising every other quarter, taking UK base rate to 1.25% by July 2017.
The other G7 country that may be tempted to follow suit is Canada, but the Bank of Canada is expected to bide its time and only start raising rates towards the very end of the year, and then perhaps tightening with a bit more gusto next year.
Elsewhere, the most notable hikes this year could be in the Philippines, Mexico and Singapore according to consensus. So if you thought 2016 would be the Year of the Rise you may need to think again. Countries whose economies were hit by the fall in commodity prices may choose to cut rates in a bid to boost their economies. These include Norway, with rates there potentially falling further this year. But the big story among the rate droppers is likely to be China, although any easing in monetary conditions to support the transition of the economy to the ‘new normal’ is expected to be relatively muted, despite the significant debt burden high real interest rates currently impose.
There’ll be plenty of no action, or near no action, for those of you who take pleasure in watching paint dry. From Japan to the Eurozone, rates are unlikely to go up for some time, while quantitative easing is still raging. Countries like Australia and India, where we saw rates fall last year, may not indulge us with any further adjustments to interest rates in 2016. Other countries in Asia Pacific that may see no movement in interest rates this year include Malaysia, while rates could start rising in South Korea next year.
We are also likely to continue witnessing negative rates in some major Western economies such as Switzerland and Sweden, with the latter likely to return to positive rates earlier than the former but probably only next year.
Overall, the fact that many large economies are likely to see rates unchanged this year should be seen as good news. It will allow the inevitable divergence in monetary policies to play out more smoothly, until the cycle firms up.
Our advice to businesses would be to pay close attention to each market, and not assume one direction for rates in all cases, as 2016 is likely to be the year of the great divergence in policy rates.
It would also be wise to revalidate assumptions as the year evolves. A lot can change that would impact rate decisions. Recovery in some of the stronger economies could stall, calling in question further tightening, while sharp exchange rate movements could cause inflation to escalate in others to the point where the central bank may choose to intervene. Many other scenarios are possible. Allowing for these would be the best a business could do.
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