The Bank of England will look for an all clear from the US Federal Reserve’s interest rate decision
When the United States Federal Reserve finally raises its benchmark interest rate after seven long years at zero, no central bank will be watching what happens more carefully than the Bank of England (BoE).
After all, the cyclical similarities between the UK and US mean markets will be looking to BoE as the next central bank in line to hike.
Both economies are currently enjoying trend growth and low unemployment. And even though US and the UK inflation is little above zero, the expectation that it will stage a hard and fast recovery in 2016 as the effects of strong currency and cheap oil diminish are similarly strong.
Still, the dovish MPC will want to wait a while for the dust to settle before following suit. As Governor Carney likes to remind us, the BoE is not following the Fed.
Read more: BoE's Minouche Shafik will not vote to hike interest rates until wages go up
Nevertheless, what happens to the US economy and markets after the hike is no less important to the BoE.
Due to the significant lags to monetary policy, there is simply no way to know if the hike has been a true success for at least a year.
But a stable treasuries curve, not too much financial market volatility – naturally there will be some – and stability in consumer confidence in the weeks that follow will be all be seen as positive signs that the Fed has made the right call.
The market optimism in the run up to this hike that the timing is right has set the stage for positive response.
The UK has a huge amount to gain and learn from this first hike by the Fed. If it goes well, it will set a strong expectation that the first UK hike is not far away. Will the BoE follow this lead or will it hang on to its dovish rhetoric?
Read more: UK households can handle an interest rate hike
It will probably follow this lead and depart from its current hedging strategy. This current strategy of adopting a dovish tone leading up to the Fed hike protects the UK economy from some of the downside risk whilst leaving space to turn hawkish if the Fed hike is well received.
Therefore, so long as the BoE receives the all clear from the Fed, expect the MPC to begin to issue clearer guidance on the timing of the first hike. This should start early next year in time for a mid-year hike.
If the Fed hike goes wrong, the MPC’s dovish status quo will simply continue with the risk that the first UK rate rise is pushed out even further.