Which central bank will raise interest rates first?

FEW central-bank governors flying into Jackson Hole, Wyoming, for the Federal Reserve Bank of Kansas City’s annual economic symposium this week are worrying yet about when to raise interest rates. Having exhausted their usual ammunition, the world’s big central banks are still trying to kick-start their economies with unconventional policies. Minutes of this month’s rate-setting meeting at the Bank of England, for example, show that Mervyn King, the governor, wanted to expand the bank’s asset-purchase plan even more aggressively than it eventually did. But the Reserve Bank of Australia (RBA) and Norges Bank, the Norwegian central bank, are the hawks among the doves. Economic commentators expect them to raise interest rates sooner than anyone else. The near-term yield curve on the pair’s government bonds is steeper than in most other countries, suggesting the markets agree.

Which central bank will move first? Australia’s economic outlook is brighter than many expected. Although GDP dipped a little at the end of last year, the economy has avoided a recession and the unemployment rate has flatlined at 5.8%, below its long-run average of 7%. Levels of consumer and business confidence are pushing two-year highs, and the RBA’s latest statement predicts economic growth for the next two years.

Norway’s outlook is rosy, too. Although its economy has shrunk a little, its central bank observes “renewed growth” and its unemployment rate of 3.1% remains the lowest in Europe. Domestic demand has remained strong, and Norwegian employers are reluctant to cut staff when they sense an imminent upturn. Because both countries primarily export staples like raw materials and food, their sales abroad have held up relatively well. Australia in particular benefits from Asian customers whose economies have remained pretty robust.

Big rate cuts were meant to bolster confidence in the face of uncertainty as much as stimulate demand. Even so, some argue the banks overreacted to begin with. Bjorn Wilhelmsen from First Securities, a financial-services firm in Oslo, says most market economists in Norway think the Norges Bank cut rates too much. Both banks have cumulatively slashed their key interest rates by more than the Federal Reserve and the European Central Bank (see chart). In Australia interest rates are at 30-year lows, which seems disproportionate to the amount of economic misery. Rate cuts in Norway and Australia are more potent than those in the euro area and America because floating-rate mortgages are common: more households have more disposable income when interest rates fall.

Deciding precisely when to tighten is tricky, however. In neither country did residential-property prices fall much from their 2007 peaks. And the latest data suggest house prices are increasing again. In Sydney and Melbourne prices rose by about 5% in the three months to the end of June; they rose even faster in Oslo.

That said, the traditional harbinger of rate rises, consumer-price inflation, remains relatively benign. Norges Bank and the RBA are forecasting domestic inflation rates below 2.8% for the next few years. Continued economic hardship overseas also makes central bankers wary of tightening too early. If trends continue, however, Norway’s central bank is the more likely to shift its rate first. Its 1.25% benchmark interest rate is below the RBA’s 3%; and similar rates of inflation mean the real rate of interest is lower, too.