Britain's interest rates will be set overseas
By Liam Halligan, Economics Editor, Sunday Telegraph
Last Updated: 11:44pm BST 05/05/2007
This week some of the world's leading central banks will make big decisions on monetary policy.
On Thursday the Bank of England is almost certain to raise interest rates to 5.5 per cent - the fourth increase in ten months. With the Consumer Price Index up by 3.1 per cent during the year to March, the Bank must be seen to act.
If that isn't enough to alarm Britain's debt-soaked consumers, most economists think rates will go up again after that, peaking at 5.75 per cent.
I don't agree. The Bank has just published data showing mortgage approvals at their lowest level for a year. The rate rises already implemented are now kicking in.
As the property market cools further, consumer spending will weaken and, in my view, inflation will ease. We'll learn more next week, when the CPI figure for April is published, along with the Bank's quarterly Inflation Report. But for now I'm sticking to my forecast that 5.5 per cent will be the peak.
Despite what is happening in Britain, though, monetary policy elsewhere this week will be of far more significance.
On Wednesday the US Federal Reserve meets and is widely expected to keep rates where they are - also 5.25 per cent. But the Fed's next move is anyone's guess, so its statement will be analysed even more closely than usual.
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No one can agree on the future direction of the American economy. Is the US in trouble, or not? Having grown by 3.3 per cent in 2006, its gross domestic product (GDP) increased at an annualised rate of only 1.3 per cent during the first three months of this year.
With house prices falling, the US is now slowing quite sharply. Last week evidence of low job creation, and a fall in hours worked, suggested that a "hard landing" might be around the corner.
Yet America could still -muscle through. Consumer spending remains strong, growing at 3.8 per cent per annum during the first quarter of 2007. And we've just seen an unexpected rebound in the ISM manufacturing index - an important bellwether of future growth in America.
The whole world should be interested in the fate of the US economy. The old adage still holds: "If America sneezes, the rest of us catch a cold." But the US lacks economic direction - a fact typified by the dollar.
In recent years the Fed has raised rates repeatedly, from 1 per cent to 5.25 per cent. But America's massive trade deficit - now £860bn and counting - has still weighed the dollar down.
Having fallen steadily for some time, the greenback has just reached $1.3682 against the euro, an all-time low. And there's an overwhelming consensus that it has further to fall.
Or is there? At the Euro-money Forex Forum in London last week, I saw a large audience of traders, analysts and other foreign exchange professionals cast some interesting anonymous votes.
More than a third of this highly informed group - 35 per cent - thought the euro would be lower against the dollar by the end of the year, implying a stronger US currency. And almost 40 per cent of the same audience said the dollar would also strengthen against the pound.
That surprised me. After all, the Eurozone is growing at almost 3 per cent, a six-year high. When the European Central Bank meets on Thursday - the third big monetary event of this week - it is expected to signal that rates will rise in June, from 3.75 per cent to 4 per cent, and perhaps again after that.
Yet despite this prospect of higher rates in the Eurozone, a big chunk of the Euro-money audience still felt the euro would weaken against the dollar.
This is even more surprising if you consider that American rates could soon be cut - pushing even more money into the euro. Almost a third of the Euro-money voters said the Fed's next move would be down, despite the reserve bank's insistence that inflation remains "the predominant concern".
These conflicting voting patterns seem to illustrate the degree of confusion in global markets, the lack of a consensus view.
To British readers, the question of how these global trends are resolved may seen tedious and arcane. That would be a mistake.
For, in my view, it is the world's currency markets, more than anything else, that will determine the future path of British interest rates. If America slumps, and US rates are cut, the dollar will fall against the pound. If Eurozone rates rise too much, and the region also slows, the euro will weaken against sterling too.
And that's the surest route to low British inflation - a strong pound. By keeping import prices in check, sterling could play a crucial role over the coming months.
If the dollar refuses to yield, and this "currency effect" doesn't happen, inflation in Britain may remain stubbornly high. Rates could then head towards 6 per cent.
So, even for us Brits, the main monetary policy action this week is definitely overseas. |
