Forecast timings of interest rate moves
26/Sep/2014 • Currency Updates•
With the Scottish referendum out of the way, medium-term focus has shifted squarely to the expected timetable of forthcoming interest rate hikes by the Bank of England and the Federal Reserve. Since we are predicting that the Federal Reserve will go first, followed shortly by the Bank of England, it is worthwhile to look at what the respective institutions are saying and what the markets are pricing in.
The Bank of England’s rates are now at 0.5%. The first hike would take it to 0.75%. As we can see below, markets price a 50% probability of this taking place at the March 2015 meeting.
By contrast, the Federal Reserve overnight unsecured rate stands in the range of 0-0.1%. It is reasonable to assume that this rate will initially be cautiously raised to 0.25% in a first step. As we can see below, the market is pricing a 50% possibility that this will happen also in March next year. Specifically, at the scheduled March 18 meeting.
At this point, it can be argued that the markets are pricing in a virtual tie, with the Bank of England winning by a nose.
We generally agree with the timing priced in for the Federal Reserve. Furthermore, the below graphs shows the expectations of individual FOMC members for where rates will finish each year (the so called dots). The median for 2015 has now moved up to nearly 1.5%. In order to achieve this level of rates by the end of 2015 while keeping hikes gradual (no more than 0.25% a meeting) the trigger must be pulled no later than the March 18 meeting.
Figure 1: Overview of FOMC participants’ assessments of appropriate monetary policy
Figure 2: Appropriate pace of policy firming
The height of each bar within figure 1 represents the number of FOMC participants who judge that, under appropriate monetary policy, the first increase in interest rate from 0% to 0.25% will occur in each specific year. The shaded circles within figure 2 indicate the value, to the nearest ¼ percent, of an individual’s judgement of the appropriate level of interest rate at the end of each calendar year and in the long run.
The Bank of England has more flexibility. It has not committed itself to any specific timing of hikes. Further, we expect ongoing weakness in Europe to moderate growth numbers in the UK. Even though unemployment in the UK is dropping fast, there is absolutely no wage pressure. In fact, labour earning growth in real terms is negative.
We expect the Federal Reserve to hike interest rates for the first time in March of 2015, in line with market expectations, with a 50% chance of this taking place. However, we think expectations for Bank of England hikes are too aggressive and do not expect rates to go up until April or May of next year.
If you want to find out how interest rate hikes may affect your currency trading, get in touch today on 0845 519 1009.