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UK and US interest rates sit at historic lows, where they have been snug for years. So does inflation. Yet now the hawks are beginning to win the argument for raising the price of credit. The problem is, that the reasoning behind such moves is flawed by its emphasis only on some of the factors that matter. Namely wages growth.
You would think that with Greece still teetering on the edge of collapse – the next bailout has not yet been agreed – and China pumping liquidity into its markets to stave off bourse collapse, and a general worry about whether Greece’s crisis can be contained or will spread to other parts of Europe, this really isn’t the right time to be talking up rates. Even talking them up, getting money markets all excited, let alone actually hiking rates!
Nevertheless, UK interest rates could rise by February 2016, all because of an obsession with rising labour costs.
According to the hawks, and even some of the neutral voters on the Bank of England’s Monetary Policy Committee, a pip higher in wages, growing at their fastest rate since 2007 when the financial crisis began, is justification to talk up rates.
Meanwhile, there is talk of a US rate hike as soon as September – late July at the FOMC’s next meeting is rather unlikely – which only helps to fuel speculation.
Markets, however, aren’t in a hurry to price in a rate hike. Neither in the US nor UK, so some sanity still prevails.
In fact, two-year US Treasuries have not repeated the actions of previous tightening cycles. In 1994, 1999 and again in 2004 yields jumped as prices fell at the front end of US government debt’s yield curve. Rather, at 0.7% the two-year US T-Note yield is at the same level it was anchored at during late 2008 at the height of the banking leg of the crisis with the Lehman Brothers collapse. In other words, yields are pretty much as low as they have been during the crisis nestled next to historically low interest rates at a range of zero to 0.25%. Markets still price in crisis rather than recovery and inflation.
It would appear US Treasuries and UK gilts are calling the bluff of their respective central banks. That’s also helping contain a re-pricing of mortgage and other interest rate-sensitive products.
And so they might. At present the notion of rising wages is fraught with problems. For one thing, most workers have had at very best flat real wage growth since 2007. But for many in the public sector and beyond, pay gains have reversed, leading to a real income drop if you take into account a modest inflation rate, which only recently dropped to zero. Even a rise in tax allowances is pegged to inflation, so hardly a generous pay rise has been enjoyed by most workers.
Perhaps ironically, the only pay rise that UK labour will record is Chancellor of the Exchequer George Osborne’s planned introduction of the national Living Wage, which comes in higher than the current national minimum wage.
At present, the UK’s national minimum wage for over 18 year olds among the 10 Organisation for Economic Co-operation & Development nations who enforce them stands at a paltry USD8/hour. Only the United States at USD7.30 and Canada at USD7.80 stand lower. Low-tax-put-the-burden-on-employers haven Luxembourg offers the highest, at USD10.80.
Given that Eurozone borrowing has jus hit a fresh record high of 92.9 per cent in the first quarter of 2015 from 92% in Q4 2014, according to figures from Eurostat, the EU’s statistical agency, this is alarming when the UK and US are talking up rates.
Why? Well, as Steven Major, head of fixed income research at HSBC, has elegantly explained, the debt increase among eurozone nations is “opportunistic borrowing”. These nations are keen to capture and lock-in debt at the current historically low interest rates in the eurozone, UK and US.
But as we all know, that is not necessarily fiscally-responsible. When the debt comes to be rolled over, a few years down the road, when rates begin to rise across the spectrum. Those same governments will be gambling that economic growth and tax receipts prevailing then will offset the fact they need to pay more back to hold onto debt or to redeem the debt. Risky.