CENTRAL BANKS TO START RAISING INTEREST RATES?

The US and UK economies, boosted by an efficient vaccine roll-out, are expected to have re-opened by the Summer. With interest rates set at emergency levels when will central banks begin tightening monetary policy?

Whilst the reopening of the major advanced economies would seem like a good time to start raising interest rates, many central banks are wrestling with the fact that inflation has persistently undershot their targets over the last decade.

The US central bank, the Federal Reserve, has already carried out a review of its monetary policy strategy. It will now target an average of 2 percent inflation. So, periods of low inflation, as experienced over the last decade, will now be offset by periods of higher inflation. In practical terms, this means that the Federal Reserve chairman Jerome Powell envisages waiting until, inflation is established above 2% for some time and full employment has been reached, before raising interest rates.

The European Central Bank, following a period of very low inflation, is currently carrying out a review of its process of setting interest rates. This is likely to result in, as per the Federal Reserve, a marked reluctance to raise interest rates.

In contrast the Bank of England has been very successful in targeting a Consumer Price Index inflation rate of 2 percent. As a result, it is likely to be one of the first central banks to begin the process of tightening monetary policy.

The desire for higher inflation on the part of the Federal Reserve and the European Central Bank is likely to amplify the next economic cycle (as monetary policy is set to become more reactive rather than proactive). As a result, this can be expected to make bond and share prices more volatile.

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This post was written by Robin