Boost for UK with US rate hike and its wider impact

Sunday 27th, December 2015 / 21:13 Written by

By Andy Jalil – Foreign Correspondent — For exporters in Britain the US interest rate rise of 0.25 percentage points has been most encouraging after both manufacturing and export had lagged behind for several months with orders from overseas as well as the UK having declined. Manufacturers have been going through one of their worse periods of growth since 2009.
UK factories are expected to end the year in recession despite a slight pick-up in activity this month, according to an industry survey.
Manufacturing orders hit a three-month high this month, helped by better exports, but companies still believe that output will fall over the coming quarter, the Confederation of British Industry’s monthly industrial trends survey found.
The order book balance rose to -7 this month from -11 in November.
Head of economics at Royal Bank of Scotland, Stephen Boyle, said a series of US rate hikes could strengthen the dollar and make UK exports cheaper for buyers in the US.
“What is more important for the UK is the pace at which US rates rise from here. Fed (Federal Reserve) members expect them to rise more and more quickly than markets currently expect. If they turn out to be correct there could be further strengthening in the dollar.”
Capital Economics’ chief North American economist, Paul Ashworth said: “We believe that a bigger-than-expected rebound in inflation next year will force the Fed to abandon its gradual philosophy, with the Fed funds rate rising to nearly 2 per cent by the end of 2016.”
But forecasts made by FOMC (Federal Open Market Committee) members showed that they believed 1.375 per cent might be an appropriate level for the FFR (Federal Funds Rate) by the end of 2016.
That suggests that the committee would vote for at least four further rate increases of 0.25 percentage points over the next year.
As widely expected further rate rises could
have an emphatic impact on the economy of several regions.
The euro zone’s direct trade links in the US are relatively weak — only 12 per cent of the region’s goods are exported there, says economist Jonathan Loynes from Capital Economics.
A faster-than-expected tightening next year may even weaken the euro further, helping the region’s exporters.
The euro has fallen 20 per cent against the dollar since February last year.
“Even if the Fed fails to control market expectations and US long term interest rates rise substantially, it is not clear that this will be mirrored by euro zone rates,” Loynes said.
“But there is no room for complacency. Should Euro zone bond yields be dragged higher or the euro fails to decline, the case for the ECB (European Central Bank) to move further in the opposite direction to the Fed will strengthen,” he added.
In Latin America, central banks are likely to begin hiking rates in response, according to Ian Shepherdson at Pantheon Macroeconomics.
The Brazilian real has fallen 32 per cent against the dollar this year, the Columbian peso has dropped 30 per cent, and the Mexican peso plunged to a new record low last week.
Shepherdson said: “We don’t expect a collapse in Latin American economies in response to the Fed’s liftoff, as most economies are better prepared for tighter financial conditions than in the past. But to safeguard the currencies, or just to try to limit the damage, most Latin American central banks will likely hike interest rates in tandem with the Fed.”
The US rate hike will also make an impact on emerging markets, the Bank of International Settlements (BIS), a club for the world’s
central banks, has warned about the rise in dollar debt outside the US.
Borrowing in dollar leaves households and businesses vulnerable to exchange rates.
The BIS reckons that emerging markets dollar borrowing has now surpassed $3 trillion (£2 trillion). Globally it puts the figure at $9 trillion.
It balances the rise of dollar debts outside the US on low rates at the Federal Reserve.
“The large emerging markets that will likely be most affected are those, such as Brazil, Russia, Turkey and to some extent South Africa, where severe domestic challenges have contributed to exchange rate and financial market instability. These sovereigns have little policy room to
protect growth and buffer themselves from external shocks,” said Steven Hess, senior vice-president at Moody’s ratings agency.