A week after the Fed decision and there is still no shortage of commentary as to whether or not they made the right decision. Now that the fireworks have settled (until the run up to October Fed meeting) it’s worth taking a look at another major central bank struggling with rate issues.
How much would a 50 bp benchmark rate hurt an economy? Well, in a way, we do have a current example. The Bank of England has had its equivalent of the Fed funds rate at 0.50% since March 2009, and although there are differences in the U.S. and U.K. economies, the psychology seems to be the same. Governor Mark Carney has repeatedly hinted in months past that a rate hike is in the plans – it is just a matter of time. But it was always somewhat assumed that the Bank of England would not move until after the Fed.
Now, everything is up in the air.
The data between the two economies is eerily similar. GDP growth in both countries is in the low 2% area. Headline inflation is essentially zero, and unemployment is 5.5% in the U.K compared to 5.1% in the U.S. Both economies of course also face the headwinds of slowing global growth and the potential for a slowdown up ahead. Leading economic indicators in the U.K. are also relatively weak.
On paper, and when measured against benchmark rates around the world, the Bank of England (BoE) has room to cut rates to 25 bp and match the current Fed Funds target, but should it? Up until its last meeting on September 10, the BoE had a tightening bias. But the reality is that such a move is not being discussed, primarily because the smart people in the room know that monetary policy gets ineffective when it is used in the extreme. Going from 50 bp to 25 really will not help the economy, and as we have seen with the Fed, moving back up will be really hard. The financial world acted last week as if panic and chaos would ensue if the Fed simply met the same benchmark rate being used by the U.K. central bank
My View: This is where economics veers off from being a purely analytical exercise and returns to a far more complex paradigm – human psychology and emotion. Central banks around the world are struggling to regain the upper ground and return reason to the markets.
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