Before the Fed meeting, markets thought that there was a 2 in 3 chance that the Federal Reserve would raise interest rates in 2015. But there are reasons to think that lifting rates is harder than it looks. Rupert Seggins & Marcus Wright look at some of the arguments around why US interest rates were left unchanged and could stay lower for longer. They also describe why this matters for interest rates in the UK.

1. Rate-lifting in the US. And why it
matters for the UK
Rupert Seggins & Marcus Wright
RBS Economics (@RBS_Economics)
September 2015

2. Before the FOMC meeting, markets put a 64% chance on the first rate rise
happening this year
2
But too much focus on this misses a bigger point. US rates could stay
lower for longer.
‘Lower for longer’ doesn’t necessarily mean interest rates cannot go
up. It can also mean central banks trying to raise rates a little, before
seeing them forced back down soon after.
0%
10%
20%
30%
40%
Probability 1st rate rise happening in*...
Source: Bloomberg. *Blank entries are months in which there is no FOMC meeting

3. -6%
-3%
0%
3%
6%
9%
Jan-90 Jan-00 Jan-10
Where the Fed Funds rate is and where it "ought" to be
Fed Funds rate that reflects QE Fed Funds Rate Mankiw Rule
Some traditional rules of thumb say rates should have risen already
3Source: Macrobond, Mankiw (2001), Wu & Xia (2014). Mankiw rule estimated using period 1990-2008.
About
2.5%

4. 4Source: Bloomberg
There is about a 1-in-4 chance that US rates won’t have risen beyond 0.5% by mid-2018
And even if the Fed follows the central expectation, rate rises will be
very gradual. Over-focussing on the first rise misses the bigger picture.

5. 5
Why lower
for longer?

6. Four things making the Fed think twice
6
Inflation is below target Inflation expectations are stable
Above average underemployment Earnings growth is not surging
-3%
0%
3%
6%
Jan-05 Jan-09 Jan-13
US inflation expectations for 5-10 years' time
Households Financial markets & finance professionals
0%
5%
10%
15%
20%
Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15
Rate of un- and under-employment 2000-2007 average
-2%
0%
2%
4%
6%
Jan-08 Jul-09 Jan-11 Jul-12 Jan-14 Jul-15
PCE inflation (the Fed's favoured measure)
0%
1%
2%
3%
4%
Mar-07 Mar-09 Mar-11 Mar-13 Mar-15
Average hourly earnings (%y/y)
Source: Macrobond, Bloomberg

7. Source: Macrobond, Bloomberg
China is a big disinflationary force for the world
• Chinese export price inflation
explains a lot of what’s going on
at the moment
• Cheap goods from China were
a key factor in the pre-crisis
world of low inflation, low
interest rates and increased risk-
taking. They still are.
• China’s slowdown has so far
led to a drop in oil and raw
materials prices and a world
trade recession. Both mean less
inflation for us.
0
10
20
30
40
50
60
70
1971-85 1986-98 1999-2013
Causesof Inflation Variability in
Advanced Economies(%)
Inflationvariabilitycausedby the same common factor
Inflationvariabilitycausedby Chinese exportprices

8. Source: Financial Stability Board, Macrobond, Bloomberg
Quantitative easing is going to continue in Europe and Japan
Central banks are keeping rates down by buying up government bonds
(Quantitative Easing or QE). While QE may have come to an end in the US
and the UK, the European Central Bank will be carrying on until Autumn
2016. The Bank of Japan’s programme is open-ended.
0
20
40
60
80
100
120
140
160
180
200
2009 2010 2011 2012 2013 2014 2015
Central bank purchases ($Bn)
Fed Bank of England
Bank of Japan Bank of Japan Forecast Purchases
ECB ECB Foreast Purchases

9. 9Source: Bloomberg, Macrobond
Recent history may worry the Fed
4
7
7
9
15
17
19
21
22
24
25
25
26
38
55
Turkey (Jan-14)
Denmark (Apr-11)
Eurozone (Apr-11)
N. Zealand (Jun-10)
N.Zealand (Mar-14)
Sweden (Jul-10)
Chile (Jun-10)
Hungary (Nov-10)
Poland (Jan-11)
Korea (Jul-10)
Australia (Oct-09)
Israel (Aug-09)
Norway (Nov-09)
Iceland (Sep-11)
Canada (Jun-10)
Number of months from 1st rate hike to first rate cut
Of the OECD central
banks that raised
rates after 2008, all
have either lowered
or begun to lower
them again

10. 10
Why is this
important for
UK interest
rates?

11. The Fed & The Bank of England – peas in a pod
11
0%
5%
10%
15%
20%
Nov-72 Nov-82 Nov-92 Nov-02 Nov-12
US & UK policy interest rates
Bank Rate Fed Funds Target Rate
Source: Macrobond
This is not surprising considering: 1) how much UK trade and
finance goes to the US and back 2) the US’ position at the
centre of the world financial system.

12. US borrowing costs influence UK ones
12Source: Macrobond
Whatever the Bank of England does, many of our interest
rates could be affected anyway. For example, UK government
bond yields track US yields closely.
0
5
10
15
20
Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07
US & UK 10 year government bond yields (%)
UK
US

13. Follow us on Twitter
13
@RBS_Economics
https://twitter.com/rbs_economics
Or visit us online

14. 14
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