2015 will be year of US interest rate rise tantrums

January 2, 2015 09:18 AM

Political uncertainty will weigh on GBP

In terms of economic performance the UK had a very good year with job creation progressing at a good pace. Indeed, at one point it looked as if the UK could beat the US at being the first of the major economies to increase interest rates. That looks increasingly less likely with the pace of UK economic growth likely to be slower than recent numbers, but still healthy.

In May the UK faces a general election and predicting the likely winner(s) has become difficult due to the country's fragmenting political landscape. The rise of the two single issue policy parties, the Scottish National Party (wants independence from UK) and the UK Independence Party (wants UK to leave EU) will greatly complicate the outcome of the UK election, possibly leading to a hung parliament.

The issuing political uncertainty will weigh on GBP.  The other negatives are the perpetual lack of growth in the Eurozone, which is helping to keep the UK's current account deficit at high levels due to a lack of export prospects across the Channel. However, migration from the stagnating Eurozone could also keep downward pressure on UK wages, which have made only very modest gains despite strong jobs growth. This removes any urgency to hike interest rates.

However, falling oil prices will prove to be a tonic for the UK economy. In the short term it could see UK inflation falling to very low levels or even into temporary deflation. As long as the UK economy is performing well, the Bank of England is unlikely to resort to a new economic stimulus programme. One area to watch would be a renewed run-up in UK real estate prices.

Given the headwinds facing a relatively healthy UK economy, interest rate rises probably won't happen until Q4 and several months after a US rise. So although GBP may not make much headway against the USD, it should be able to hold its own against the other majors. 

Likely trading range for GBP/USD: 1.5300-1.6000 with 1.5500 acting as strong support.

The battle to re-start Eurozone economy will heat up

H1 if not Q1 should see the European Central Bank begin a quantitative easing programme as that seems to be the tool most likely to quickly increase inflation and inflation expectations. Though ECB President Mario Draghi very clearly wants to do it, he is up against deep divisions within the central bank and strong German reticence, which could even lead to legal action.

The ECB will also continue to favour a weaker EUR, which will have a knock on effect on other European currencies, particularly CHF and SEK and to a lesser extent GBP.  This could create regional tension as other European central banks feel obliged to keep pace with EUR depreciation.
The Eurozone is mired in stagnation and appears to be heading for deflation, which could unleash problems with heavily indebted Italy. In a deflationary environment the real value of debts increases, placing increasing strain on borrowers.

Falling oil prices, which will increase deflationary pressures, will sway the argument in favour of doing QE. However, lower energy prices, if maintained, should help the Eurozone economy, as should the strong U.S. economy. Both should counter-act the effect on exports of sanctions against Russia and the slowing Chinese economy.

It's actually possible that the Eurozone could deliver a surprise in terms of economic performance during H2 – once factors, such as lower energy prices and QE have worked their way into the real economy. Also, lower energy prices will increase the size of the Eurozone's already large current account surplus. Nonetheless, the Eurozone remains stuck with many structural issues and increasingly dire population demographics, which will continue to be a drag on growth.  

Likely trading range for EUR/USD: 1.1500-1.2500 with strong support at 1.2000.

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About the Author

Justin Pugsley is the forex and gold markets analyst for New Zealand-based trading platform provider MahiFX. He is a keen student of markets, economics and history. Prior to working with MahiFX, Justin worked for a number of leading media organisations such as Thomson-Reuters and Dow Jones/Wall Street Journal.