Borrowing is likely to stay cheap in 2015 as a drop in inflation puts pay to talk of higher interest rates
Christmas is usually followed by a rush off to the sales but borrowers need not hurry as cut-price loans are likely to remain for most, if not all, of 2015. Acting like retailers with surplus stock to sell after Christmas, central banks slashed interest rates after the global financial crisis. Six years later, there are growing calls for this to be reversed in countries such as the US and the UK due to as a strengthening economic recovery backed by more people finding jobs. Yet, plans for higher interest rates have been way laid with falling inflation suggesting that all is not well with the economy. With unemployment and inflation likely to fall further in 2015, there seems to be few reasons for any changes to be made to interest rates over the next 12 months.
The Federal Reserve and the Bank of England are in the midst of a dilemma – like a shopper not sure of where to head first to snap up some bargains after Christmas. Unemployment data suggests that the economic recovery is becoming more entrenched with the proportion of Americans and Brits without jobs now below 6%. Yet, despite more workers being hired, companies are still holding back from investing to expand output. Aggregate demand is also suffering due to cuts to government spending resulting in an economic recovery that is still patchy.
If the stuttering economy is giving central banks reason to worry, it is inflation that is the real sticking point getting in the way of higher interest rates. The extent at which prices are rising (or falling) has been adopted by central banks as a gauge for the health of the economy. It is thus a point of frustration that inflation is heading downward as other signs, such as lower unemployment, suggest that the economy is picking up. These mixed signals from the economy mean that Federal Reserve and the Bank of England are caught in two minds in terms of what do to with interest rates.
Best to stay put
Things are not likely to get any easier for central banks considering that the trends in unemployment and inflation are not likely to change any time soon. With companies not yet willing to spend big on new equipment, it makes sense to employ more workers (who are relatively cheap) to get things done. Lower commodity prices is the main cause behind falling inflation and a rebound in commodity markets is not likely as shifts in demand and supply of commodities taking years to change. Neither are consumers in any mood for higher prices considering that wages have not kept up with inflation over the past few years.
All this suggests that 2015 will be more of the same and interest rates are also unlikely to change. Some will argue that interest rates need to rise to give central banks leeway to act in case of other threats to the economy. Others will claim that the economic recovery means that inflation will be just around the corner and central banks need to pre-empt any jumps in prices. But these are risky strategies considering that a bit of inflation in the future will do less damage to the economy than a premature hike in interest rates.
A still fragile recovery means that, like any shopper out after Christmas, the economy could also do with a bargain (in the form of low interest rates).