Analysts and forecasters in the US expect that the Fed will hold the fed funds rate at its current zero to 25 bp target until around the middle of 2015. Meanwhile, expectations about Europe are shifting.
Recent comments from the UK by the former deputy governor of the Bank of England and others suggest that British interest rates could begin a slow climb sooner than in the US, maybe as soon the start of 2015.
The UK housing market is very strong with prices climbing rapidly. Moreover, the strength is not just high-priced London houses sought by foreigners; it is in many parts of the country.
Higher interest rates and a shift in government policies on support for mortgages are likely. In both the US and the UK, the rise in interest rates will be slow and gradual and the eventual peak is likely to be modest compared to levels experienced in the years immediately before the financial crisis.
In the US the central bank will be feeling its way as it adjusts the operating procedures to controlling interest rates through the rates paid by the Fed on reserves rather than traditional open market operations.
Due to quantitative easing and the extreme growth of the Fed’s balance sheet, it cannot control interest rates by draining reserves from the banking system – excess reserves are much too large. Instead, it will raise the rate it pays banks on their deposits at the central bank. The result is that banks will be encouraged to either raise the rates they charge on loans or shift funds from lending to their deposit accounts at the Fed. The central bank may need some time to fine tune its actions.
The outlook in Europe is different. The European Central Bank is concerned that the economy is weakening and that deflation is a growing risk.