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14th January 2016
We Have Lift-off!

On 15th December, somewhere in the barren desert steppe of Kazakhstan, a Soyuz-FG rocket was launched. Catching a ride on board was Major Tim Peake, the first UK astronaut to be sent to the International Space Station.

Peake and his two fellow travellers were propelled from Earth from the very same cosmodrome from which Yuri Gagarin became the first man to be launched into space – though it remains unclear whether the three astronauts followed what is now a cosmonaut tradition of stopping the bus escorting them to the launchpad in order to relieve themselves against the rear right tyre, as Gagarin did almost fifty-five years ago.

However, this was not the only significant launch to take place during that week. The following day, on the other side of the world in Washington DC, the American central bank also announced lift-off.

The twelve-member Federal Open Market Committee of the US Federal Reserve unanimously voted to raise interest rates for the first time in nearly a decade, intent upon marking the end of the financial crisis. By increasing the federal funds rate (the rate at which banks lend to each other) by a quarter of a percentage point to a range of 0.25%-0.5%, the central bank clearly indicated their confidence in the US economic recovery, and rightly so.

The unemployment rate in America has fallen to its pre-recession level of 5%, while core inflation (which strips out the effects of fuel and food costs) is comfortably at the Federal Reserve’s long-term target of 2%. Chair of the Federal Reserve Janet Yellen stated that she was confident that the US economy was “quite sound” and was not about to slip back into recession.

The monumental move ended a staggering eighty-four consecutive months of zero interest rate policy (or ZIRP), which is only a year longer than Major Peake’s intensive training for his mission in space. In fact, the last time the US central bank increased rates was in June 2006, during a pre-iPhone era when Tony Blair was Prime Minister, David Beckham was England captain and smoking was still allowed in pubs.

While the rate hike was quite small, markets will now shift their focus to the trajectory of future increases, which the Federal Reserve has indicated as being fairly gradual. It remains to be seen whether the move could clear the path for a similar increase here in Britain. The recovery seems to be going just as well this side of the pond, though the Bank of England’s Monetary Policy Committee are yet to increase the base interest rate from its current low of 0.5%. While a rate increase will result in higher borrowing costs for both businesses and individuals, it should come as a small but welcome relief to savers.

The increase in US interest rates provides a stark comparison to the loose monetary policy occurring elsewhere in the world. The European Central Bank and the Bank of Japan are still pumping money heavily into their respective economies via various forms of quantitative easing while maintaining rock-bottom interest rates in order to spur economic growth. For the next few years, there is no doubt the divergence between central banks will be a key theme for markets. Though we hope this “one small step” from the Federal Reserve will mark the beginning of a long-awaited return to normality.