“On this basis, we may thus be facing another two years of negative real policy rates – in the US and UK,” he adds.
Paul Ashworth, chief US economist at Capital Economics, notes that the Fed does not just have the drop in inflation to contend with, but also the weakening unemployment rate this year, which hovered around 4.4% in June.
“For that reason, we still expect the Fed to continue raising interest rates in the second half of this year,” he says. “Nevertheless, the odds of a September rate hike are fading.”
This all means there is now a divergence between the Fed and the Bank of England with the latter looking likely to raise rates. UK inflation is higher at 2.9% and three members of the Monetary Policy Committee voted for a rise at the last meeting.
Since then, two members of the committee who did not vote for higher rates, the BoE’s chief economist Andrew Haldane and governor, Mark Carney, have hinted they are coming around to the view that UK rates may need to rise soon.
Michael Baxter, economics commentator at The Share Centre, says this reversal in views from the Fed and Bank of England has surprised markets, which could be supportive of sterling relative to the dollar.
“The new views coming out of the UK and US central banks may not seem especially radical, but the markets have been surprised,” he adds.
“They had priced in a quite different prognosis for UK and US rates for the next few months, and when the markets are surprised in this way, currency markets can be affected.”
Whether or not this divergence becomes more pronounced will of course become clearer in the months to come. Much depends on the UK inflation figures for June, which we only have to wait until 18 July to find out.
