Coming into the year, investors were figuring out how they wouldtrade between two paths set on one side by monetary tightening fromthe Federal Reserve and, eventually, the Bank of England (BOE), andon the other by Bank of Japan and European Central Bank (ECB)easing.

Now, those investors are rethinking that divide as the U.S. andU.K. economies succumb to signs of a worsening global slowdown,forcing their central banks to rethink the interest-rate outlook.Any split now will be led by how much euro-area and Japaneseauthorities press ahead with looser policy.

The reassessment following a volatile start to the year suggestsa world economy still in need of synchronous and easy monetarypolicy if it is to escape the threats of low inflation and slowingChinese demand. It also means a review of the trade that propelledthe U.S. dollar higher.

“We're having peak divergence,” said Torsten Slok, chiefinternational economist at Deutsche Bank AG in New York.

Behind the switch is the turmoil in equity and bond marketstriggered by uncertainty over the direction of China's economy at atime when sliding commodity prices are compounding thedisinflationary pressures dogging all key economies. With the Fedlast week saying it was “closely monitoring global economic andfinancial developments,” BOE Governor Mark Carney joined the choruson Thursday by bemoaning an “unforgiving world” for derailing hisinflation forecasts.

“Something has got to give,” said Michael Gapen, chief U.S.economist at Barclays Plc in New York. “You can't have thecombination of steady, if unspectacular, fundamentals and volatilemarkets for too long.”

In the U.S., Fed Chair Janet Yellen and her colleagues onthe FOMCvoted to raise the benchmark federal funds rate in December forthe first time since 2006, leading the charge out of anunprecedented period of low interest rates and unconventionalstimulus worldwide.

Global Shift Away from Plans to Raise Rates

Markets have since shifted their view, rejecting the Fed's December suggestion of four rate hikes this year andsending the dollar toward its worst week since 2009.

As for the Bank of England, a Morgan Stanley index based onmarket prices suggests no rate hike for 30 months. Societe GeneraleSA said yesterday it was no longer predicting any increase at allin the 0.5 percent benchmark in the current growth cycle, havingpreviously predicted Carney would lift it to 2.5 percent.

For the Fed, traders have alsopared bets that it will beable to increase rates even once in 2016,partly fueled by the central bank's signalling that financial andeconomic volatility may be shifting the risks to their forecast.Fed Chair Janet Yellen can validate or temper those views when shetestifies before Congress next week.

The January employment report, which showed payroll gains of151,000 and a decline in the unemployment rate to 4.9 percent,almost an eight-year low, was supportive of the Fed's forecast forcontinued labor market strength this year.

Yellen “has to recognize the troublesome markets and that it'sdifficult to quantify their impact,” said Slok. “If inflation andemployment deteriorate then she won't hike.”

As the anchor of the global monetary system, a more hesitant Fedalso throws the plans of others into disarray. Carney is signalinghe won't be moving toward an increase in the cost of borrowingquite as quickly as first thought. Colleague Ian McCafferty alsoshelved his call for higher rates this week to leave the bank'sMonetary Policy Committee unanimous for the first time sinceJuly.

As Carney pushed out his estimate of when U.K. inflation wouldreturn to target to 2018, investors dialed back bets on when thefirst rate hike will come. Market pricing even suggests a cut ismore likely than a rise in 2016.

While Carney slows down on the path to higher rates, hiscounterpart at the ECB, Mario Draghi, is ready to pick up the paceof monetary easing. The 19-nation euro area's jobless rate stilllanguishes above 10 percent, while the U.K. and the U.S. edgecloser to full employment. The European Commission cut its growthand inflation forecasts for the region this week and now sees 2016price growth averaging just 0.5 percent.

With a review of current policy due in March, Draghi spoke onThursday of “forces” in the global economy “conspiring to holdinflation down.” The ECB could push its deposit rate, currently atminus 0.30 percent, even lower and add to the pace of assetpurchases, now at 60 billion euros (US$67 billion) a month. TheGoverning Council is set to decide on policy on March 10.

The Bank of Japan's (BOJ's) shock foray into negative rates onJan. 29 sets the scene for further cuts this year, particularlyafter currency traders rebuffed the stimulus move, leaving the yenpoised to make its biggest weekly advance in more than six years.BOJ chief Haruhiko Kuroda said on Feb. 3 that he may cut interestrates again.

Indeed, with the early movers in the tightening process taking apause, accelerating stimulus plans elsewhere create a fresh set ofimpulses, according to Nariman Behravesh, chief economist at IHSInc. in Lexington, Massachusetts.

“Say the Fed and the BOE do nothing, but you have the Bank ofJapan in negative territory now and the ECB maybe even deeper intonegative territory,” he said. “You have greater divergence there,but just not the type we thought we were going to have.”

–With assistance from Richard Jones and Carlos Torres.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.