As we move into the second half of 2015, central banks’ policy stance will be front-of-mind for investors. Loose monetary policy has supported global growth since the financial crisis but, as recovery becomes more entrenched, central banks are finally looking to exit this period of extraordinary accommodation and start tightening policy over the next few months.
The clearest indication of this tightening is likely to be interest rate rises in response to strengthening economic data. For UK investors, the Bank of England is a natural focus and recent signs of a pick-up in wage growth and inflation have sparked renewed speculation about a rate rise this year.
However, the biggest question for investors – especially those with more global exposure – remains across the Atlantic, where the US Federal Reserve looks likely to be the first of the major central banks to raise rates. Both the BoE and the Fed will take their first moves towards normalisation with caution.
At home: BoE’s gradual tightening timeline remains on track
In the UK, economic data has been mixed throughout the year and the recovery remains fairly unbalanced. Wage growth has shown some strong momentum and inflation has turned positive again in recent weeks.
Of course, stronger wage growth and inflation data is good news for UK consumption and the housing market but I do not think it is likely to be enough to significantly shift the timeline for potential BoE tightening, leading to rate rises any sooner than expected.
At this point, there are too many unknowns on the horizon: fiscal tightening (with more detail to be announced by the Conservative majority government later in the summer), Greece-related risks (and any potential EU spillover that could impact the UK’s major trade and financial channels), the impact of the strong pound and the prospect of an EU referendum (likely to take place by the end of 2017).
This uncertain context means it is unlikely the BoE will make the first move on rate hikes. I think a rise in the first half of 2016 is possible but, again, it will depend on how the risk factors evolve.
Across the pond: Fed will make the first move
Speculation has intensified this year on the Fed’s plans to raise interest rates. Expectations of rate rises have been pushed out repeatedly in the first half, as economic data has been weak. However, the time is drawing nearer and I think we could see a rise in December (although risks continue to skew towards 2016).
The message from this month’s Federal Open Market Committee meeting was somewhat dovish but it seems to me the market’s interpretation was more so than it actually implied.
While growth projections for the US economy were revised down significantly (now at 1.8 per cent to 2 per cent), the majority of FOMC participants still expect two or three hikes this year (as we see from the “dot plot” used by FOMC members to express their estimations for the path of interest rates), which comes across as very hawkish.
As the US data improves gradually over the coming months, hawks might gain a bit more traction again. But it is still unlikely we will see enough improvement – domestically or externally – to justify a September hike.
I do not believe financial stability concerns are likely to trump concerns about the economy and push the Fed to hike to avoid a further bubble build-up. Together with watching the data, it will very important for investors to listen to the FOMC officials’ speeches and comments through the summer.
They will be preparing the market for further action and signalling their intentions well in advance. But whether the first hike happens in September, December, March, or even later next year, the pace of tightening thereafter is likely to be extremely gradual.
In the context of current global growth, where economic data has been mixed in the first half of this year and where numerous risks remain, tightening monetary policy is going to be all about caution.
This is about striking a balance between fostering a still-uneven global recovery and “getting back to normal” after the financial crisis.
Normalisation has a wide range of implications (consider the possible “taper tantrum” effect Fed tightening could have on emerging markets, for example) and it is clear that no central bank will wish to be responsible for potential negative consequences.
On the other hand, policy cannot remain loose forever, particularly as this low interest rate environment brings unintended consequences of concerns about financial instability. The next few months for central banks will be about navigating this path with as much caution as possible.
Anna Stupnytska is global economist at Fidelity Solutions