Will 2015 see the US and UK raise interest rates?

Speaking to a panel of economists on the outlook for the economy and the markets, one notable theme among many stuck out.

They remained focussed on the US and what interest rates in the world’s biggest economy would mean for rates in Britain and the rest of the world.

It’s already evident in currency markets.

This year, for the first time since the turn of the century, the US dollar rose against all major currencies.

The euro and the Japanese yen have dropped by 12% against the dollar and the Chinese RMB has fallen by 2.4% versus the dollar – its first annual decline since 2009.

Greater demand for the dollar by investors reflects their expectation that interest rates will rise in the US, so they are piling in to gain a higher return than in the euro zone and Japan.

In those economies, interest rates are likely to not only remain at nearly zero, but the European Central Bank and the Bank of Japan are both poised to continue to loosen monetary policy.

Japan is already injecting some $700 billion of cash annually until inflation doubles to hit their 2% target.

The ECB appears poised for quantitative easing (QE) as well, since deflation – or falling prices – is a real risk.

A graph showing the decline of the FTSE 100 in 2008
The US and UK imposed low interest rates in response to the 2008 financial crisis
So, if US interest rates start to rise from the current 0-0.25% around the middle of the year as currently forecast by analysts, there is profit to be made for traders.

China offers a higher interest rate of course, but with a currency that isn’t freely convertible, a fairly closed capital account, and state-dominated financial markets, it’s not an open market for trades.

The weaker RMB reflects slower economic growth which has already led to the first rate cut in a couple of years and may well lead to more in 2015, putting China more in line with the looser stance of Japan and Europe than the US.

Britain is closer to the US in that economists expect the first interest rate rises to take place in the coming year or so.

The conventional view is that the Bank of England won’t raise rates until after the Federal Reserve, which would put any UK rate rises after the mid-point of the year on current projections.

In fact, Bloomberg data show that traders don’t expect a rate rise before November.

Still, the talk is of rate rises, which has pushed Sterling to rise by over 5% in 2014, the best performer after the US dollar among developed economies’ currencies.

As the Bank of England is keen to stress, any rate rises would be gradual and likely be an initial increase of 0.25%. But it would be the first move of many toward a more normal interest rate, which had averaged 5% before the crisis.

The new trend rate may be lower since growth is unlikely to be as robust, but it would still be a world away from the record low 0.5% rate that’s been in place since March 2009.

There are a lot of factors that could shift the schedule for rate rises, of course.

A man walks in front of the London Stock Exchange
UK equity markets are anticipating a rise in interest rates
These include economic growth, what will happen to oil prices (their decline has driven down inflation), and unemployment, to name a few key ones.

Still, the expectation is that rates will begin to “normalise” for the US and Britain in the coming year or so.

Mortgages will be affected as will equity markets which have been boosted by record low interest rates and cheap cash injections that had only ended in the US a couple of months ago in October.

For the FTSE, the impact has already begun to be felt as the benchmark stock index ended the year down 2.7%. More money has moved into UK gilts. Demand has pushed down yields on UK government bonds; the yield on 30-year debt has fallen below 2.5%, a record low.

Indeed, if you had put your money into bonds, you would have gained 14%, the most since 2011, versus losing nearly 3% on stocks, in 2014.

Any forecasts of rates and markets have to be taken with a huge grain of salt. But, the direction seems clear.

After a long seven years, 2015 could be when the US and UK economies and markets finally get back to normal.

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