By ROBERT HARLEY 03/02/2006
The US Federal Reserve this week ended the Alan Greenspan era with a 14th consecutive hike in its key interest rate. At 4.5%, the Fed Rate now equals the UK Bank of England Base Rate.
| "This is a far cry from 2002/03 when the Fed Rate fell as low as 1%" |
This is a far cry from 2002/2003 when the Fed Rate fell as low as 1%, reflecting the Federal Reserve’s desperation to breathe life back into the US economy following the major stockmarket downturn. As the chart below shows, the US rate has varied widely since the beginning of the decade compared to a fairly static UK rate.
The tangled economic web in which we exist means it’s hard to predict exactly how this latest increase will impact on global economies. However if the rise causes the Dollar to strengthen against Sterling, as some expect, this would be bad news for the UK. A weakened Sterling means higher commodity and oil prices (because they’re priced in US$) and consumer goods imported from the Far East become more expensive (as most Far Eastern currencies are pegged to the US$). This in turn will threaten inflation, already under fire from rising oil prices last year, posing a major threat to the UK economy (as discussed in our recent ‘Outlook for 2006’ article).
| "Looking at the bigger picture, the US and UK both suffer from similar structural weaknesses..." |
Looking at the bigger picture, the US and UK both suffer from similar structural weaknesses: big Government spending deficits, a poor trade balance and over-extended consumers. The latest Fed rise will do little to solve this in isolation. The required medicine most likely includes a sharp increase in taxes and continued interest rate rises, probably too bitter a pill for any Government to swallow.
On a brighter note companies in both economies are generally robust, which lessens fears of a stockmarket downturn in the near term.