Mates' Rates

Mates' Rates

over 4 years ago3 mins

The US central bank appears poised to lower interest rates later this month – and the country’s stock market has hit all-time highs. The UK now seems likely to follow suit – but shares there haven’t responded in kind. It all comes down to why rate cuts are on the cards…

🕰️ Recap

  • Last month, the European Central Bank said it might lower the region’s interest rates in order to boost economic growth

  • A day later, the US Federal Reserve said it wouldn’t raise interest rates – and might instead soon lower them

  • And that same week, the Bank of England said the UK’s interest rates could go in either direction

  • A stronger-than-expected US jobs report last week pared investors’ expectations regarding the size of forthcoming rate cuts

  • Data this week showed that the UK economy grew in May – but likely shrank in the second quarter overall

🔗 Connecting the dots

Central banks typically cut interest rates when an economy’s growth isn’t as strong as hoped – something usually reflected in rising unemployment and low price inflation. While these aren’t necessarily the case right now in “developed markets” like the US and Europe, there’s currently a demonstrable slowing – and in some cases shrinking – of economic growth happening across the world as a whole.

The US appears to be on the front foot: political pressure aside, the Federal Reserve says it’s willing to pre-emptively cut rates to sustain America’s longest-ever economic expansion. Given that the country’s economy is still growing (albeit more slowly than before) and adding jobs, and that recent inflation has exceeded forecasts, such an economy-boosting measure might seem premature. But investors are happy: lower borrowing costs should help companies increase their profits, and people have been buying up US stocks in anticipation.

The UK’s central bank – which just last month was considering raising interest rates in 2019 – might now also end up lowering them instead. But it would do so from a position of weakness compared to the US. The Bank of England has already lowered its growth predictions for the second quarter and acknowledged that an unruly Brexit could call for even more dramatic rate cuts. Sustained uncertainty about the fate of the British economy has kept investors away from British stocks – despite a UK rate cut in theory having an identical impact to an American one.

🥡 Takeaways

Lower interest rates typically bring down the value of a country’s currency: lower returns from low-risk investments can prompt investors to pull their money out of a country and seek better rates elsewhere. And if lower interest rates are accompanying a weakening economy, investors may want to move money into areas where better growth should mean higher returns from their investments. When peripatetic investors sell one currency to buy another, it can push down the value of the one being sold.

One effect of a cheaper currency is that a country’s exports appear cheaper – and therefore more attractive – to foreign buyers. That may boost demand for that country’s products and help economic growth. But as with ride-hailing services, several countries effectively cutting their prices at the same time can cause a price war. The US, eurozone, China – and potentially the UK – would all benefit from cheaper currencies boosting international demand for their products, but that benefit could be limited if other currencies got cheaper too...

🎯 Also on our radar

The world’s biggest luxury carmaker Daimler was more Damn-ler on Friday: it warned that its profit would be even lower than expected for the fourth time this year. Daimler said it had uncovered new information related to the unlawful manipulation of diesel emissions data, which is already crumpling its earnings – but will now cost the company even more. Drive for five, anyone?

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