The heat is rising on the interest rate debate
The hot topic at this year's annual meeting of central bankers in Jackson Hole, US, will be interest rates – with developed economies still cautious about raising their rates and emerging economies becoming increasingly frustrated by this inaction.
Central banking has become a game of chicken in which no-one wants to be the first major player to raise rates. Attendees at August’s central bankers summit in Jackson Hole, US will be analysing presentations, papers and off-the-cuff remarks in informal settings to try and figure out the answer to this mystery.
The title of the summit is 'Re-evaluating labour market dynamics' and US Federal Reserve chairwoman Janet Yellen’s speech is called 'Labour markets'. With her emphasis on the unemployment rate the challenge will be to decipher how far the US labour market has to move before inflation becomes an issue and rates have to rise.
Economists at Citi argue, in a paper called 'Our Fed call: Fed poised for on-time or early liftoff?' – that quantitative easing (QE) will end in October 2014, with no interest rate rise before September 2015. The UK, by contrast, seems much nearer to a rate rise following the news that two members of the nine member monetary policy committee (MPC) voted to raise rates at a recent meeting – the first departure from consensus for three years.
The big fear in both the UK and the US is that an early rise derails the recovery by strengthening the currency, which harms exports and by increasing borrowing costs which impacts home owners and companies. As with all these things the psychological impact – worries about how much further rates could go – may be worse than the reality of any increase.
Could the discussions at Jackson Hole affect the outcome? If some central bankers think that other central bankers are postponing the decision may they be inclined to do so too? They may also be influenced by continuing weakness in the eurozone, where the pressure is not for a rate rise from the European Central Bank but for Fed-style QE.
Central bankers from the emerging markets are becoming increasingly frustrated by the situation, and there is the potential for turning a dull meeting into a more exciting one as both camps make their arguments. As long as major currencies such as the dollar and the euro are being pushed lower by central bank policies, the emerging market economies risk being damaged by their own overvalued exchange rates. By lowering their own rates to correct the situation they risk inflationary bubbles.
The world’s economies are more interconnected than ever with monetary policies in one country impacting on another. The situation points the way to a more coordinated approach but we are a long way away from that. In the meantime, the games of chicken and guessing will continue.
