All eyes on US and UK as rate rise edges closer

The noise on Greece and China has been keeping the markets on red alert, however, all eyes are still on the US and UK central banks as they suggest they are getting closer to finally increasing interest rates.

Both the Federal Reserve chief Janet Yellen and the Bank of England governor Mark Carney have suggested a rate hike might happen in the coming months as fundamentals start to look better for both economies.

But which country is actually ready to start increasing interest rates first?

While it is widely thought that the US will raise rates first, many experts argue the UK is better placed to raise rates before next year and maybe even before the US, given its stronger economic data.

Speaking to the new Treasury select committee last week, Carney said “the point at which interest rates may begin to rise is moving closer, given the performance of the economy”. Later last week, in a speech at Lincoln Cathedral, he said he expects rates to rise over the next three years, but only getting “about half as high as historical averages”, or to about 2 per cent.

UK economic data would, in fact, support Carney’s decision.

According to the latest figures from the Office for National Statistics, total pay in the UK increased an annual 3.2 per cent in the three months through May.

In comparison, wage growth for the US was 2.2 per cent for the same period, according to the US Bureau of Labor Statistics.

UK sensitivities 

Axa Wealth head of investing Adrian Lowcock says the UK does look better than the US in its fundamentals, with employment and retail figures looking more robust. However the UK is “much more sensitive” to an interest rate rise, especially because of the country’s reliance on variable rate mortgages.

He adds: “An early rate hike from the UK could be possible but in recent history that has never happened.”

Compared to the rest of the world, the UK and the US central banks have always been very data dependent, primarily looking at labour market and job creation data.

Lowcock believes such data is fundamental in deciding whether to increase rates or not, but it is not enough.

He says: “Markets have always been driven by data, particularly US payroll figures, and it has been a big driver of market movement and confidence.

“Although the central banks are data driven you have to question the validity of the data. They have got to try to extrapolate what they expect to happen as well.”

Both central banks have maintained interest rates at unchanged and low levels for a long time.

The BoE has kept interest rates at the record low of 0.5 per cent for more than six years, while US interest rates have been held at between zero and 0.25 per cent since 2008.

Lowcock adds: “Traditionally it has been more about the US leading with a bigger impact when raising rates. Also the US is strong enough to withstand a rate rise.”

Hargreaves Landsdown senior analyst Laith Khalaf says to a certain extent the US was the first to start QE and so “it will make more sense for it to move first”.

However, Sarasin & Partners chief investment officer Guy Monson believes an early rate rise for the UK is indeed possible, probably happening in November.

He says: “If it was Carney versus Yellen, I’d say he has got a slightly overheated property market in the UK, and a quite stubborn current account problem and that would all suggest to me that he would like to start the rate hike cycle.”

According to the ONS, the UK current account deficit was down from an upwardly revised £28.9bn in the final three months of 2014, but it still represents the equivalent of 5.8 per cent of the UK GDP.

Also, a push to increase rates could come from external events.

In her recent speech to Congress, Yellen said potentially the Greek crisis, as well as the slowdown and market correction in China, could harm US growth. But many do not believe these threats will impact any decisions on rates with both Yellen and Carney’s statements being intended to “prepare the market” instead.

Spence adds as Carney and his colleagues “are excellent communicators” financial markets should be very well prepared for the first rise.

Khalaf says: “Yellen decides as part of a committee but her comments are still very significant. Her assessment to introducing interest rates gives the market the time to readjust.”

He adds: “You had a similar idea two years ago when the Fed decided about the taper tantrum. That was an idea of getting the market ready. It is signalling your intentions before anything happens.”

From an investment point of view, an earlier rate hike from both the UK and US would unsurprisingly cause a market reaction. Axa Investment Managers senior economist David Page says if the Fed increases rates in September we will see a rise in US treasuries and UK gilts.

Sterling pressure

He adds market reactions to an earlier UK rate rise will put pressure on sterling “which is something the BoE would want to avoid”.

Cerno Capital co-founder and managing partner James Spence adds: “The effect on equities of a single hike should be short-lived. It is not at all obvious that the price of longer-term bonds would be impacted as neither economic growth nor inflation are kicking up.”

While most economists agree that ‘crisis’-level interest rates are no longer warranted for the US economy, many are wary about frailties the first rate hike might expose, according to Monson.

He says: “Nine years of rock-bottom rates could easily have encouraged misallocation of capital. As rates rise, will these vulnerabilities jeopardise the recovery itself?”

Monson adds: “Markets are going to be volatile. I don’t think that the market is necessarily going to react to this rate rise quite as well as people might expect.”

He advises investors to be more cautious in the next six months: “We haven’t really experienced what rate rises do to financial markets against the backdrop of record levels of global private and public debt.”