Will UK Be Next In Line For Policy Shift?

In this new age globalized world, interest rates have a critical role to play in deciding the health of the economy. Due to its complex relations with other economic indicators like inflation and growth, interest rates have behaved differently in different countries under various circumstances. One assumption underlying this reasoning is that borrowing rates of major economies have stronger impact on conditions in smaller countries. This has prompted today’s astute investor to keep a watchful eye on the interest rate policies of the world.

Speaking about rates, one cannot deny markets obsession with the timings of US borrowing rates all thanks to its better-than-the-rest economic credentials. In the recent FOMC meeting, the US Federal Reserve left their federal funds target range unchanged at 0-0.25 percent. The reason behind this move was the troubling external factors that weakened the global demand and played with the economic indicators especially inflation of the nation.

This did not go down well with the investors. Not forgetting how aggressively markets trade and need reasons to speculate, all eyes have now turned towards the Bank of England. Though its importance has always been secondary to US, discussions related to UK rates has now gained importance on the coffee tables of the worldly know how.

UK has been through many booms, busts and crises. Its economy enjoyed sturdiness until it crossed paths with the 2008 financial crisis and went on to became one of the worst affected of Western European countries. Businesses suffered due to plunging sales and profitability along with lack of monetary support from banks. This led to companies downsizing to reduce cost which heightened unemployment thereby affecting government’s tax revenues. From 0.1 percent in Q1 of 2008, UK’s GDP came down to -2.1 percent in Q4 of 2008. Britain’s economy officially entered a period of recession.

A country's economy cannot be self-corrected. The prodigy is to do the right thing in times of crisis. The paradigm shift in UK's economic policy helped the nation to bounce back with zeal and uphold its place as the world's 6th largest economy. To save several of their illiquid and undercapitalized banks, BoE regulators reduced their borrowing rates from 5.5 percent in 2008 to 0.5 percent in 2015. This has undoubtedly been the best thing to have happened to the nation.

Britain's economy grew the fastest rate since then. Current growth rate is 2.6 percent which is the strongest in the G7 since 2007. Consumer demands revived that eventually increased the output thereby helping the manufacturing and service sector to expand. This benefitted the working group as job opportunities and wages increased. Deflation finally took the exit door as inflation paved its way in the economy which was a sign of bloom. According to the IMF, UK was the only economy after US to grow faster than any other advanced economy in 2014.

Starting months of 2015 have had some extraordinary events that have taken the entire globe in a whiff. With respect to the Euro-zone, persistent problems of the debt-ridden countries especially Greece has resulted in sluggish growth of the entire zone not forgetting the latest immigration problem. Wider global geopolitical risks related to the situation in Russia/Ukraine and the Middle East in particular has further added to the woes. Not forgetting the dragon nation i.e. China that has pulled the entire world in its vicious circle of economic distress. All these international developments have affected the global demand.

Risks to Britain's growth due to this are weighted to the downside in the short term. Subdue global demand accompanied with sterling's strength has taken a toll on UK's exports. This eventually is hurting the manufacturing sector owing to decline in foreign orders. Service sector that contributes to around 78 percent of the total GDP have also had the weakest rate of expansion in over two years. Inflation returned to zero in August thereby fuelling expectations that BoE is still months away from raising its benchmark rate from 0.5 per cent.

The other side of coin is perhaps different. Consumer confidence of the nation has made a 15-year high in August accompanied with upward scaling in business confidence. Reasons for the same are strengthening property markets, low inflation and rising wages. This shows that consumers are confident about the nation and its growth recovery is a fact and not fiction.

Recent minutes of the BOE’s policy decision has been very hawkish as policymakers are optimistic about UK’s growth machine. Though inflation remains below the 2 percent target, it is expected to linger close to zero for a few months before picking up around the turn of the year. The governor, Mark Carney, stated that ongoing Chinese turmoil is temporary in nature. He pointed towards improving labour markets which could drive the inflation in the upward direction. He ended the speech by warning the Britain’s homeowners to prepare for a rate hike around the turn of the year. This could change the faith of United Kingdom in the long-run.