In December 2015, the US Federal Reserve raised the interest rates for the first time in about 9 years. This marked the beginning of tightening the monetary policy in the US under the leadership of the Fed chair Ms. Janet Yellen. As the year 2016 began, there were speculations from economic analysts that the rate hike would continue gradually throughout the year. However, do far the speculations have been proven wrong; with weak economic data on a month by month basis deferring the decision to raise the interest rates into further into the future. After the Bank of England decided to cut its rates and also return to its programme of printing money; the US Fed was served with yet another spanner in their tool box which might delay the rate hike.
The Bank of England lowered its interest rate for the first time in seven years from 0.5% to 0.25%. The BOE governor Mr. Mark Carney said that the move was a result of the forecasted slow economic growth due to the Brexit referendum that ultimately removed the United Kingdom from the European Union. In his statement, Mr. Carney also indicated that there is a possibility of further rate drops before the year ends. He however dismissed a possibility of a negative interest rate regime. The central bank also lowered its economic growth forecast for the UK in 2017 from 2.3% to 0.8% only. Again this was based on the fact that after Brexit vote, the UK is expected to slow down as its economy transitions into the new status out of the larger European Union free market.
The US Fed now finds itself in a complicated situation since it cannot just continue with its rate hike endeavors when its fellow large economies globally are moving in the opposite direction. Tightening the US monetary policy while the other large economic counterparts are loosening theirs would be detrimental to the US economy. The Fed therefore needs to tread softly and give more weight to these external forces when considering the rate hike in the US.
This year alone, the dollar has dipped by 3% against its global peers and this adds more worry to the fed that raising the interest rates will strengthen the dollar and make the financial conditions much tighter. Neil Wilson an analyst at the forex trading company ETX Capital explained that, “Raising the US interest rate will result to capital inflows to the US and that will lead to a higher demand for the dollar; which will eventually push its price up at the forex markets and hence make it stronger against its peers.”
The Fed still has some appetite for a rate hike this year although economic analysts think otherwise. The Federal Open Market Committee in its December 2015 made the first move to tightening the monetary policy in the US. At the same time they promised that 4 other increase of the interest rates would follow in 2016. This promise puts them under pressure to deliver on it but the economic headwinds from the inter-connected global economy are not giving them a chance to execute on their plans. Even locally, the Fed is facing an economy that is literary crawling with an average growth rate of 1% in the first half of 2016. With all these factors combined, the Fed will find it hard to justify a rate hike in the second half of 2016 solely based on the growth in the economy between now and December 2016.
Adding a gloomier picture to the rate hike scene is the US presidential elections coming up in November 8th 2016. With the political parties presidential candidates’ nominations behind us and the conventions done with, the election fever is fast catching up. From historical data, election years and the months preceding the actual election dates usually are associated with slower economic growth due to political uncertainty. If this condition holds true in this year too, we can therefore not expect the second half of 2016 to experience higher growth rates than the first half of the year. This therefore means that the US Fed has its hands tied with regard to increasing interest rates any further this year.