Weekly Economic Briefing

A new neutral?

24 March 2015

Global Overview

  • Both short and long-term interest rates have been falling across the globe, suggesting a shift in neutral interest rates. There are a whole host of reasons for this decline, including weaker potential growth, impairments in the financial sector, debt, low inflation and regulation.
  • These forces are not expected to be permanent. Neutral interest rates should start to rise as headwinds to growth soften and inflation moves to target. This should allow central banks to edge away from extraordinary policy settings.
  • There is evidence that neutral rates in the US and UK have fallen since the crisis, although this is notoriously difficult to quantify. Policymakers will have to balance the risks between tightening too early or too late.
  • Policymakers in the Eurozone and Japan failed to push interest rates far enough below neutral to provide the necessary stimulus to their economies. The recent activism on the monetary policy front is helping correct this shortcoming.
  • China is taking steps towards interest rate liberalisation as it looks to prevent further capital misallocation. This might cause a rise in market rates which may need to be offset by looser monetary policy to support the economy.
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US

Last week’s FOMC minutes revealed downward revisions to growth, inflation and unemployment forecasts. The dovish underlying message now makes it unlikely that rates will rise in June.

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UK

UK neutral interest rates have fallen over recent years. While some of these drags will fade, we expect rates to rise to a lower level than was the case in previous monetary
tightening cycles.

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Europe

The ECB loosened policy less than the BoE and the Fed after the crisis, despite evidence that neutral rates are lower in Europe. Recent moves have helped to address this policy mistake.

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Japan

Policymakers have learned from Japan’s negligence over its stubbornly high real interest rates. For Messers Abe and Kuroda, structural reforms will be just as important as monetary policy.

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Emerging Markets

China is marching towards interest rate liberalisation; the deposit rate remains the last key step. Market-determined interest rates may increase initially as banks compete for deposits.

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Standard Life Investments’ Global Strategy team provide regular analysis of the key economic data that has been influencing financial markets.

Available on a weekly basis, the Weekly Economic Briefing takes a detailed look at the global economic issues that have been impacting our investment strategy. The regional approach aims to provide an easy-to-navigate guide to the most recent developments in the global economy.

The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

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