20150515-NATIXIS-Why_have_the_Federal_Reserve_and_the_Bank_of_England_not_hiked_their_interest_rates_earlier__12页_775kb

FLASH ECONOMICS - Summary

Core Content

This document analyzes the reasons behind the delayed interest rate hikes by the Federal Reserve (US) and the Bank of England (UK), despite the economic recovery that had already begun. It highlights the potential risks associated with maintaining low interest rates for an extended period and explores several possible explanations for the central banks' cautious approach.

Main Points

1. Delayed Interest Rate Hikes

• The US and UK central banks have not raised interest rates as expected.
• Financial markets anticipate a slow increase in rates starting from the second half of 2015.
• The delay is considered risky, as it could lead to asset-price bubbles and low rates during the next recession.

2. Economic Recovery Context

• In the US, the first monetary policy tightening typically occurs two years after the cycle trough and three to four years before the unemployment rate bottoms out.
• In the UK, tightening usually occurs two years after the cycle trough and two to three years before the unemployment rate bottoms out.
• The current economic situation suggests that the central banks should have started raising rates earlier than they have.

3. Key Explanations for Delayed Hikes

a. Low Inflation

• Inflation and expected inflation have been declining since 2012 in both countries.
• This low inflation is attributed to:
  • Weak wage and unit labor cost growth due to reduced bargaining power of wage earners.
  • A drop in energy prices caused by weak global demand.

b. Growth Dependence on Expansionary Monetary Policy

• In the UK, growth has been heavily supported by expansionary monetary policy, particularly through wealth effects and rising asset prices.
• In the US, growth has been driven by corporate investment and industrial production, which are influenced by low energy prices and strong cost competitiveness.
• Central banks are reluctant to tighten policy if it might slow down this growth.

c. Risk to Asset Prices and Investors

• Very low interest rates have led to long periods of low long-term interest rates, rising stock prices, and tightening risk premia.
• The risk of sharply falling asset prices due to the unwinding of carry-trade positions is a concern.
• Investors who have accumulated assets at high prices over the past years may suffer if rates rise.

d. Impact on Public Finances

• The public debt ratio has remained high due to slow fiscal deficit reduction.
• An increase in long-term interest rates would harm public finances, especially in the US and UK, where the private sector has deleveraged.
• This makes central banks hesitant to raise rates.

e. International Debt in USD or GBP

• The US has a large amount of international debt in its currency, which could lead to negative spillover effects on other countries.
• This is a key factor for the US, as raising interest rates could affect foreign debtors.

f. Risk of Exchange-Rate Appreciation

• Central banks may avoid raising rates to prevent sharp exchange-rate appreciation.
• A stronger currency can harm export competitiveness and lead to a loss of market share.
• The dollar's appreciation due to expectations of rate hikes is a clear example of this risk.

Key Information

• The document provides charts and tables to support its analysis, including:
  • Trends in nominal GDP, monetary policy rates, and unemployment rates.
  • Data on inflation, asset prices, and public debt ratios.
  • Details on international debt in USD and GBP.
• It emphasizes the importance of understanding the timing of monetary policy and the consequences of prolonged low rates.
• The main conclusion is that while the delay in rate hikes is dangerous, it is understandable due to the multiple risks involved.

Conclusion

The Federal Reserve and the Bank of England have postponed interest rate hikes due to a combination of factors including low inflation, growth dependency on monetary stimulus, risks to asset prices, public debt concerns, international debt exposure, and exchange rate risks. While these reasons are plausible, the document warns that such a delay could lead to economic instability if not addressed in time.