There was never going to be a right time for the Federal Reserve to raise interest rates, yet now, as the US central bank prepares for a December “lift-off”, it seems the first move in seven years will be both too early and too late.
Too early, because many of the underlying weaknesses of the US economic system are still evident: the low rate of Americans’ participation in the workforce; a lack of above-trend wage growth to drive up shop prices. Then there is the insipid global growth forecasts brought on by a decline in global trade.
And too late because this is not the moment in the business cycle to cool spending – the traditional reason for deploying higher interest rates. Spending has already moderated.
So the Fed needs to ask itself why, after six years of recovery, do businesses and households need it to intervene with higher borrowing costs if they are already restraining themselves from borrowing more.
Without the European farce that followed the 2010 botched rescue of Greece, and the splurge in spending by the Chinese (that Beijing subsequently needed to calm this year with its own borrowing clampdown), US interest rates would already be 2%, not 0.25%. Reading the business cycle, the Fed’s moment has passed.
Even though the UK’s recovery is no more than three years old, the Bank of England is in much the same position.
That is not a universally held view. Goldman Sachs said in a long analysis this week of the global economy that the situation was relatively benign and the momentum in the US economy was set fair for several years more. It was certainly strong enough to withstand an interest rate rise or three, said its economists. the same applied to Britain.
Meanwhile the prospect of further stimulus in the eurozone, while it should ultimately be positive for global growth, illustrates the ongoing weakness of the currency bloc.
The European Central Bank has hinted that it may need to ease further in the minutes of its meeting in Malta earlier this month.
ECB boss Mario Draghi is concerned he will fail to get inflation back to its target. Most significantly, businesses report new orders are slowing along with GDP.
Dhaval Joshi, an economist at BCA Research, said the Fed could be misled by focusing on unemployment and wages.
“The trouble is that unemployment is one of the most lagging indicators of the economy – a measure of what was happening 3-6 months ago, rather than what is happening now, or what will happen 3-6 months ahead. The clear and present danger is that although the lagging indicators are strong, the best leading indicators are all suggesting weakening growth ahead.
“So, trapped by its own rhetoric and promises, the Fed risks making a policy mistake on December 16. When the market comes to realise that growth isn’t fine, but interest rates are nevertheless rising, the view that Fed tightening is bullish could quickly evaporate, and indeed reverse,” he said.
A similar loss of confidence could undermine Draghi too, as investors begin to see him as a Wizard of Oz figure, madly pulling levers to very little effect.
As Joshi said, the ECB can push interest rates further into negative territory, but not much more, “because that could do more harm than good”.
Negative rates would squeeze profit margins in a still-fragile banking sector, or force banks to pass cuts on to savers, encouraging them to seek higher returns in riskier assets.
“Meanwhile, the average euro area five-year yield, at just 0.25%, is already within a whisker of a new all-time low. So realistically, the ECB is approaching the limit of what it can achieve with monetary policy. When investors come to realise this, any ECB-induced exuberance risks evaporating,” he said.
To some extent Brussels has recognised the problem and relaxed its austerity rules, allowing countries like Italy and Spain to boost spending. It is unlikely to be enough.
This article was written by Phillip Inman Economics correspondent, for theguardian.com on Thursday 19th November 2015 18.36 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010