Bank of England at forefront of rates dilemma

london - An unexpectedly strong global economy raises doubts about raising interest rates

The Bank of England will find itself facing a question this week that is set to trouble many other central banks this year - does an unexpectedly strong global economy mean it should press ahead with raising interest rates?

For the BoE - and its Indian, Australian and New Zealand counterparts - the answer over the next few days is likely to be no, as domestic uncertainties for now outweigh the inflationary pressure of a powerful global upswing.

But the odds of moves further away from the emergency level stimulus of the financial crisis are shortening. In government bond markets, yields on 10-year US, German and British debt have leapt by more than 30 basis points since the start of the year and two-year US yields are their highest since 2008.

BoE governor Mark Carney takes centrestage on Thursday, when he will set out the central bank's thinking on Britain's prospects, barely a year before the country is due to leave the European Union.

No economist thinks a BoE rate hike is coming this week, according to Reuters polls. But markets see a 50 per cent chance that there will be another move in May, a relatively quick follow-up to the BoE rate hike in November, the first for a decade.

UBS' chief economist, Arend Kapteyn, recently changed his mind to predict a May rate rise due to recent strength in the global economy - assuming that Prime Minister Theresa May can get a temporary Brexit deal before then.

"We think the data lines up for a brief window where they can hike," he said.

Much later and there is a risk that the domestic economy may sour, as businesses hold off on investment and hiring in the months running up to Britain's departure from the EU.

Politics is also likely to exert its sway over the Reserve Bank of India's thinking this week, after an expansionary budget on Thursday which boosted rural spending and predicted that India would become the world's fastest-growing major economy.

A decision to jack up farmers' production subsidies was especially likely to intensify the RBI's worries about above-target inflation, economists said.
Going the other way is Brazil, which is likely to cut rates on Wednesday as the country slowly pulls out of more than two years of economic malaise.

Services smile
UBS has just upgraded its global growth forecasts to pencil in expansion of 4.1 per cent for this year - which would be the fastest since 2011 - after 3.9 per cent growth in 2017.

More evidence of the strength of the global recovery is likely to come on Monday, with a raft of services PMIs for advanced economies.

Manufacturing data previously showed factory activity hitting multi-year highs, and an early version of the services PMI for the Eurozone rose to its highest since 2006.

US data on Friday showed the biggest annual rise in hourly wages since 2009.

"The activity data at the beginning of this week should go some way to confirming that the world economy started 2018 on the right foot," HSBC economist James Pomeroy said.

Further confirmation was likely to come from Chinese trade data and German industrial orders, he added.

Overall, open economies such as Australia and New Zealand should not focus too much on current below-target inflation and prepare to raise rates in the second half of the year, he said.

"I think this is a global theme, but will be much more acute in those countries where you have financial stability concerns," he said, highlighting a rise in household debt.

For Kapteyn of UBS, the slide in the US dollar - which has fallen 4 per cent so far this year on a trade-weighted basis - made the case much less obvious for rate rises outside the United States because it will ease inflation pressures.

More than usual, survey data in advanced economies looked too good to be true.

"You are seeing very strong growth data, but very little price or wage pressure. The volatility in currencies is dwarfing the reduction in slack," he said.

By contrast, new Federal Reserve chairman Jerome Powell, whose four-year term started on Saturday, may have to raise rates more often than the three times planned for this year - especially if the US Congress loosens the fiscal purse-strings.

"Dollar weakness is reducing the freedom of the Fed. They're going to become very, very sensitive to any upward surprise in growth or wage forecasts. For the rest of the world, it's largely the opposite," Kapteyn said. - Reuters