Friday December 18, 2015 - 15:52:47 GMT
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A LOOK AHEAD: ECONOMIC DATA ANALYSIS
Friday 18 December 2015
MONETARY POLICY DIVERGENCE TO CONTINUE IN 2016
The extent to which US interest rates rise will be a key market focus in 2016
Policy divergence to continue as both the ECB and BoJ could loosen further
BoE biased towards raising rates but seems in no hurry to start the process
US central bank hikes interest rates. As expected the Fed hiked interest rates by 0.25% at its December meeting. Initial market reaction has been mostly positive. The US dollar has modestly risen; bond markets, including US Treasuries are little changed, while equity markets have responded calmly. What happens next, in part depends on the Fed’s next steps. Its guidance is that any further interest rate rises will be ‘gradual’. This seems consistent with current market pricing, which does not imply another rate increase until around the middle of next year and only two quarter-point rises in 2016 in total. However, the FOMC’s interest rate forecasts continue to point to a faster pace of tightening. How this ‘gap’ between market and FOMC expectations closes will determine how financial markets behave over the coming year. In this final weekly for this year, we will look at other key themes for 2016. More detail can be found in our IFO - The Year Ahead document.
Policy divergence to continue. While the FOMC seems set to tighten further, other central banks are continuing to ease. In the euro area, the ECB is on alert to increase its policy stimulus further. Similarly in Japan, a weak inflation outlook means that further monetary policy easing next year remains a risk.
UK monetary policy sandwiched between the Fed and the ECB. Private sector domestic demand is expected to continue to drive UK economic growth. The Bank of England is biased towards tightening monetary policy but, with inflation so low, it is in no hurry. Consequently, we expect it to lag the Fed by several months with interest rate hikes not expected in the UK until the second half of 2016.
Upside surprise in the oil price? Oil prices remain under pressure reflecting excess supply. This has pushed down headline inflation rates across advanced economies. This may persist in the short term but, further out, a rebound seems likely. Crude oil price could rise back above $60pbl next year (from $37pbl currently), heralding a pickup in inflation.
Emerging market outlook remains mixed. India is forecast to be the outperformer among major emerging market economies next year. In China, double-digit growth rates are a relic of the past. A gradual slowdown is forecast to continue as the economy reorients towards services and domestic consumption. The potential for recovery in global commodity prices should provide some relief for Russia next year. However, substantial economic and political challenges remain in Brazil where its economy is expected to remain in recession.
Multitude of risks. Substantial debt levels remain a key risk around the world, which may limit the room for fiscal stimulus in response to any sign of slowing growth. Other risks include further destabilisation of the Middle East, which could intensify the refugee crisis in Europe and also create more tension between Russia and the West. In the UK, the timing and outcome of the EU Referendum is also a potential source of uncertainty, especially if the polls are close in the run-up to the vote.
Bond yields to rise. The long-awaited start to US monetary tightening and the expected rise in UK rates later next year should support higher global bond yields in 2016.
A year of two halves for currencies? The start of US policy normalisation is forecast to lead to further upward pressure on the US dollar in the first half of 2016. The euro could rebound later in the year if euro area economic growth continues to pick up.
The next Economic Data Analysis will be released on Monday 4th January. In the meantime, we wish all of you a Merry Christmas and a Happy New Year.
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