Economics Weekly - How low can official interest rates go? Weekly economic data preview - Will the BoE cut interest rates again next month?
Economics Weekly 10 November 2008
How low can official
interest rates go?
Slowing economic growth
and falling inflation is leading to record low interest ratesâ€¦
Interest rates are
being cut aggressively around the world as economic growth slows and as price
inflation either falls back from recent peaks or is set to fall sharply in the
months ahead. A worsening of the credit crisis since the failure of Lehman
Brothers two months ago, has noticeably hit expectations for growth and
inflation. In many countries, prospects for price inflation are helped by the
fact that wage inflation is well-behaved, meaning that it is well below price
inflation. How low can interest rates go in some of the major economies? One
starting point is the approach used in the so-called â€˜Taylor ruleâ€™, which calculates
the extent to which inflation and growth deviate from their long run averages,
subtracts this from long run real interest rates and then adds expected
inflation to get an estimate of what the short term official interest rate
should be. We have calculated these rates for the US, UK and eurozone. What do
they show? The answer is that overall they show that interest rates in the
advanced economies have a further 1 to 2 percentage points to fall.
An analysis of the
results from calculating Taylor rule rates for the US reveals an official
rate of 3.75%, well above the current interest rate of 1%, see chart b. But
central banks set short term interest rates in a forward looking way and, if
this is taken into account, then it explains why there is such a large gap between
the two rates. But in order for that calculation to work, we have to assume that
price inflation falls well below its long term average, and that the economy
weakens further, so that a big negative output gap opens up. This is, of
course, exactly what forecasts are suggesting and so doing this largely
explains the gap between the actual central bank base rate and the Taylor rule rate. IMF
forecasts now show that growth in the advanced economies will be negative in
2009, the first synchronised decline since the second world war.
â€¦analysis using the â€˜Taylor ruleâ€™ suggests that
interest rates can be cut furtherâ€¦
So assuming more
negative forecast outcomes for economic growth and inflation into a Taylor rule framework
supports the current 1% level for US interest rates. Interestingly, official
short term interest rates could even be cut below the levels seen so far, if
growth and inflation weaken further. This is instructive, as the history of the
Taylor rule set against the official actual
central bank rate shows that it has generally been a good guide to actual
rates. In addition, market interest rates are still well above the official
rate in the US, UK and euro area, see
chart a, even though they have come down in the last few days. If this is
allowed for, then it too suggests that the Fed funds rate should be 1%, in
order to get market interest rates to a level implied by the Taylor rule, based on the
traditional spread between official rates and market rates.
...in the case of the
UK, to 1Â½% in 2009, if the economy experiences a downturn as severe as in 1990,
and to zero if recession carries over into 2010
For the UK, what does the Taylor rule suggest? Chart c
shows that the rule suggested that Bank rate should be cut to 3%, though in
early 2009. But this does not take into consideration the fact that market rates
are well above the official rate. If this is taken into account, then it
suggests that UK rates should be cut to
2% in the near future. Our forecast is that rates will be cut Â½% in December to
2.5% and then in February 2009 to 2%, but it could happen sooner. They could
then stay at 2% throughout 2009. The fiscal policy response may well play a key
role in whether this becomes the actual outcome. If tax cuts and spending
increases are large enough to promote economic recovery, then Bank rate may not
be cut asaggressively as we currently expect. We have also calculated where UK rates may have to be
cut to, if the economy slips into a deep recession, see chart c. This would
open up a wide enough output gap for price inflation to turn negative, which is
a view held by some. In this case, UK interest rates would fall
to 1Â½% by mid 2009 and, if the recession persists into 2010, to zero by the end
of that year.
It looks as if interest
rates in many of the major advanced economies will fall to new lows
In the case of the eurozone, the Taylor rule suggests that the
ECB was right to cut rates to the current3.75%. However, given
market dislocation and the spread of market rates over the ECB repo rate, eurozone rates will need to come down by another 1.25 percentage points to
2.5% to get money market ratesdown to about 3Â½%.
The Taylor rule
approach highlights that there are further cuts in short term interest to come,
even though they have already been cut to historically very low levels in all
three of the economies looked at in this analysis. Another factor encouraging
cuts in nominal interest rates is that if inflation falls and interest rates
are not cut, that translates into a rise in real interest rates at a time when
the economy is in recession. To avoid this, Central banks in the advanced
economies are willing to cut interest rates to below inflation, at least in
terms of backward-looking past measures of inflation. In terms of forward looking
real interest rates, lower nominal interest rates now are still needed to
prevent too sharp a rise in future real interest rates.
After the unprecedented
rate cut by the Bank of England last week, market participants
will this week closely scrutinize the 2009 and 2010 forecasts for UK gdp growth and
inflation in the quarterly Inflation Report. The report will be published on
Wednesday. In terms of economic indicators, UK producer prices data
on Monday should show a gradual easing of pipeline inflation pressures in
October. Unemployment data on Wednesday may heighten concerns about the pace of
economic contraction and may underscore the gloomy prospects for household
spending. Retail sales and consumer confidence data will be released in the US, where President-elect
Obama may announce who will replace Mr Paulson as the next Treasury Secretary.
In the euro zone, the preliminary estimate of Q3 gdp may show that the region
slipped into recession as gdp growth contracts for a 2nd successive quarter.
â€¢ BoE governor King
famously quipped eight years ago that monetary policy should be 'boring',
referring to how a transparent central bank should lead decisions on interest
rates being predictable. The Bank was anything but that last Thursday when it
slashed interest rates by 150bps to 3.0%. The question is where does this leave
the economy, and what will happen next to Base rate? (see main article) The
reason given for the large cut was the risk that economic growth could contract
sharply and inflation would undershoot the 2% target in the medium term. Labour
market data will be published on Wednesday and are forecast to show that
companies laid off staff in October at the
fastest rate since the early 1990's. This will push up the unemployment rate
closer to 6%, a level that we suspect may be breached this winter. With more people
on the dole, spending power being eroded and credit conditions still tight for
most businesses, the risk is that the last week's rate cut may not be the last.
The worsening profile of economic activity at the start of Q4 suggests that
another quarter of contracting gdp is extremely likely in Q4. With inflation
set to fall rapidly during the course of 2009, this should keep the BoE in
'rate cutting mode' over the next few months. To this end, the Inflation Report
on Wednesday should help make it clearer whether
the Bank will keep interest rates on hold in December after making up
substantial ground last week, or whether it believes that more rate cuts are
warranted. The Report will also make clear how soon the Bank believes that
inflation will fall back to the 2% target next year - falling house prices and
lower interest rates will weigh heavily on RPI - and what the chances are of
inflation undershooting 2% in 2009 or 2010 based on implied market interest
â€¢ Focus in the US will be on retail
sales data for October and consumer confidence. Q4 is traditionally the strongest
quarter of the year for US retailers but the latest information from the labour
market and quarterly lending data suggest retailers may struggle to meet this
year's targets. Foreign trade data will be published on Thursday and are
forecast to show a decline in the deficit in October to $57.1bn due to the fall
in the value of oil imports. The Treasury will this week auction $54bn in 3
year, 10 year and 30 year benchmark paper to fund part of the Treasury rescue
package. Separately, US banks have until Friday to submit their request to
qualify for funds under the $250bn Troubled Asset Relief Programme (TARP). The
specifics of the programme and proposals of how the new administration plans to
revive economic growth through fiscal policy are likely to receive some attention
â€¢ The European Central
Bank also lowered interest rates last week, by 0.5% to 3.25%. The prospect of another
reduction in December remains intact after president Trichet said that a
further fall in interest rates 'is possible'. We believe a 0.5% reduction next
month is possible. This week's Q3 gdp and inflation data for the euro zone will
be a guide to how realistic this is. We expect gdp growth to have contracted
0.1% q/q last quarter, led by falls in business investment, household spending
and weak growth in exports. This would mark a second successive negative figure
and would officially put the economy in recession. Annual CPI is likely to have
slowed in October to 3.4%, the lowest since January.
Any documentation, reports, correspondence or other
material or information in whatever form be it electronic, textual or
otherwise is based on sources believed to be reliable, however neither the Bank
nor its directors, officers or employees warrant accuracy, completeness or
otherwise, or accept responsibility for any error, omission or other
inaccuracy, or for any consequences arising from any reliance upon such information.
The facts and data contained are not, and should under no circumstances be
treated as an offer or solicitation to offer, to buy or sell any product, nor
are they intended to be a substitute for commercial judgement or professional
or legal advice, and you should not act in reliance upon any of the facts and
data contained, without first obtaining professional advice relevant to your
circumstances. Expressions of opinion may be subject to change without notice.
Although warrants and/or derivative instruments can be utilised for the
management of investment risk, some of these products are unsuitable for many
investors. The facts and data contained are therefore not intended for the use
of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc.
Lloyds TSB Bank plc is authorised and regulated by the Financial Services
Authority and is a signatory to the Banking Codes, and represents only the
Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and
Forex Trading News
Daily Forex Market News Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Forex News Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."
Actionable trading levels delivered to YOUR charts in real-time.
Mon 10 Sep 2018 AA 08:30 GB- GDP, Trade, Output Tue 11 Sep 2018 AA 08:30 GB- Employment Decision A 09:00 DE- ZEW Survey Wed 12 Sep 2018 A 12:30 US- PPI A 14:30 US- EIA Crude A 18:00 US- Beige Book Thu 13 Sep 2018 A 1:30 AU- Employment AA 11:00 GB- Bank of England Decision AA 11:45 EZ- European Central Bank Decision A 12:30 US- Weekly Jobless AA 12:30 US- CPI Fri 14 Sep 2018 A 08:30 GB- GDP AA 12:30 US- Retail Sales A 13:15 US- Industrial Production AA 14:00 US- prelim University of Michigan
John M. Bland, MBA co-founding Partner, Global-View.com
Global-View Affiliate Program
We are starting an affiliate program to market some of our products.
Send me an email if you would be interested or if you know someone who would like to be an affiliate. Generous commissions payout for those accepted.
Put the word "affiliate" in the email subject line.
Veteran FX Trader, Max McKegg, forecasts all the Major currencies and the Australasians; providing Daily and Medium Term Trading forecasts to subscribers, who include large Banks the world over, as well as individual traders in more than 30 different countries.
looking for your first broker or do you need of a new one? There are
more critical things to consider than you might have thought.
We were trading long before there were online brokers. Global-View
has been directly involved with the industry since its infancy. We've
seen everything and are up-to-data with recent regulatory changes.
The Global-View Forex Forum is the hub for currency trading on the web. Founded in 1996, it was the original forex forum and is still the place where forex traders around the globe come 24/7 looking for currency trading ideas, breaking forex news, fx trading rumors, fx flows and more. This is where you can find a full suite of forex trading tools, including a complete fx database, forex chart points, live currency rates, and live fx charts. In addition, there is a forex brokers directory where you can compare forex brokers. There is also a forex brokers hotline where you can ask for help choosing a forex broker that meets your individual fx trading needs. Interact on the same venue to discuss forex trading.
The forex forum is where traders come to discuss the forex market. It is one of the few places where forex traders of all levels of experience, from novice to professionals, interact on the same venue to discuss forex trading. There is also the GVI Forex, which is a private subscription service where professional and experienced currency traders meet in a private forex forum. it is like a virtual forex trading room. This is open to forex traders of all levels of experience to view but only experienced currency tradingprofessionals can post.
Currency trading charts are updated daily using the forex trading ranges posted in the Global-View forex database. You will also find technical indicators on the fx trading charts, e.g. moving averages for currencies such as the EURUSD. This is another forex trading tool provided by Global-View.com.
The forex database can be used to access high, low, close daily forex ranges for key currency pairs, such as the EURUSD, USDJPY, USDCHF, GBPUSD, USDCAD, AUD, NZD and major crosses, including EURJPY, EURGBP, EURCHF, GBPJPY, GBPCHF and CHFJPY. Data for these currency trading pairs dating back to January 1, 1999 can be downloaded to an Excel spreadsheet.
Forex chart points are in a currency trading table that includes; latest fx tradinghigh-low-close range, Bollinger Bands, Fibonacci retracement levels, daily forex pivot points support and resistance levels, average daily forex range, MACD for the different currency trading pairs. You can look on the forex forum for updates when one of the fx trading tools is updated.
Global-View also offers a full fx trading chart gallery that includes fx pairs, such as the EURUSD, commodities, stocks and bonds. In a fx trading world where markets are integrated, the chart gallery is a valuable trading tool. Look for updates on the Forex Forum when the chart gallery is updated.
Global-View.com also offers a forex blog, where articles of interest for currency trading are posted throughout the day. The forex blog articles come from outside sources, including forex brokers research as well as from the professionals at Global-View.com. This forex blog includes the Daily Forex View, Market Chatter and technical forex blog updates. In additional to its real time forex forum, there are also Member Forums available for more in depth forex trading discussions.
WARNING: FOREIGN EXCHANGE TRADING AND INVESTMENT IN DERIVATIVES
CAN BE VERY SPECULATIVE AND MAY RESULT IN LOSSES AS WELL AS PROFITS. FOREIGN
EXCHANGE AND DERIVATIVES TRADING IS NOT SUITABLE FOR MANY MEMBERS OF THE
PUBLIC AND ONLY RISK CAPITAL SHOULD BE APPLIED. THE WEBSITE DOES NOT TAKE
INTO ACCOUNT SPECIAL INVESTMENT GOALS, THE FINANCIAL SITUATION OR SPECIFIC
REQUIREMENTS OF INDIVIDUAL USERS. YOU SHOULD CAREFULLY CONSIDER YOUR FINANCIAL
SITUATION AND CONSULT YOUR FINANCIAL ADVISORS AS TO THE SUITABILITY TO YOUR
SITUATION PRIOR TO MAKING ANY INVESTMENT OR ENTERING INTO ANY TRANSACTIONS.