Expectations for interest rate hikes
29/Oct/2014 • Currency Updates•
The market focus is now firmly on interest rates and speculation as to when the major world economies will hike rates has intensified in the past few weeks.
Since this time last month, expectations and forecasts on the timing of the Bank of England (BoE) interest rate hike have altered quite significantly in the wake of weaker than expected inflation and a more dovish stance adopted by the central bank. CPI fell to a five year low of 1.2% in September (Figure 1) and since then economists have been pushing further and further back their expectations for a hike. As we can see from Figure 2 below, Bloomberg’s World Interest Rate Probability (WIRP) calculations now put the chances of a December 2014 hike, from an unlikely 19.2% in September, to an even more improbable current level of 1.4%. We have to look ahead all the way to the September/October 2015 meetings to find a greater than 50% chance of an interest rate hike.
Figure 1: UK Consumer Price Index (2009-2014)
The BoE minutes released last week showed that UK policy makers are generally concerned with the overall health of the economy, amid lower than targeted inflation and weak global growth. Seven of the nine MPC members again voted to keep interest rates at a record low of 0.5% this month with Chief BoE Economist, Andrew Haldane, “gloomier” on the state of the economy, stating that “interest rates could remain lower for longer, certainly [longer] than I had expected three months ago”.
Figure 2: UK interest rate forecast. Source: Bloomberg
Markets now price just a 20% probability of a March increase and a 50% probability for September of next year. Deputy Governor of the BoE, Minouche Shafik, this week reiterated that unless policy makers see more signs of price pressures growing in the economy then it is more than likely that the BoE may not increase rates until summer 2015 at the very earliest.
We predicted last month that the Federal Reserve would make their interest rate hike first, followed shortly by the BoE. While we still think this will be the case, we now believe that the Fed will hike rates significantly sooner than the UK, although still slightly later than anticipated. As shown below in Figure 3, the markets now place a 40% probability that rates will go up in March 2015, compared to 56% last month, with the more likely timeframe to be a June 2015 hike, with markets currently pricing this at 58%.
Figure 3: US interest rate forecast. Source: Bloomberg
This supports our view that the US is, at this moment in time, the strongest performer among the major economies, outperforming its major counterparts that are being dragged down by the Eurozone permacession. Weak economic growth within the Eurozone is not such a problem for the world’s biggest economy which is largely self-contained. Stronger than expected inflation of 1.7% in September, decreasing unemployment to 5.9% (Figure 4) and increased consumer confidence will all be major factors in the upcoming Federal Reserve meetings. It now seems almost inevitable that the US will be the first of the major world economies to hike interest rates. Interest rate markets give a 58% chance that this will take place at the June FOMC meeting. We think market pricing is roughly correct in this instance.
Figure 4: US Unemployment Rate (2009-2014)
If you want to find out how interest rate hikes may affect your currency trading, get in touch today on 0845 519 1009.