A screen displays the Fed’s rate announcement as a trader works on the floor of the New York Stock Exchange (NYSE), on November 2, 2022.
Brendan McDermid | Reuters
The US Federal Reserve, European Central Bank, and Bank of England are all expected to raise interest rates again this week as they make their first policy announcements for 2023.
Economists will be watching the rhetoric of policymakers closely for clues to the trajectory of future rate hikes this year, as the three major central banks try to engineer a soft landing for their respective economies without allowing inflation to rise. regain momentum.
The three banks are expected to reaffirm their commitment to bringing inflation back to targets near 2%, but recent positive data has fueled hopes that central banks will eventually be able to slow the pace of rate hikes.
Nick Chatters, fixed income manager at Aegon Asset Management, said the task for market watchers is to “telegraphically deduce” from this week’s press conferences what Fed Chair Jerome Powell and the Chairwoman of the ECB Christine Lagarde think of the “terminal rate” and how long they intend to maintain a restrictive monetary policy before starting to normalize.
The Federal Open Market Committee concludes its meeting on Wednesday, before the Bank of England and the ECB deliver their decisions on Thursday.
Since December’s FOMC meeting, economic data showing slackening wage growth and inflationary pressures, as well as other worrying signals of growth in activity, have bolstered the case for the Fed to enacts a rate hike of 0.25 percentage points – a marked decline from the giant moves seen in 2022.
The market is now pricing this eventuality, but the key question is what the FOMC will indicate on further rate hikes in 2023.
“We think the Fed’s trajectory this year is better thought out in terms of where it should go rather than what the fund’s rate target level should be.” Goldman Sachs Chief US Economist David Mericle said in a note Friday.
“The goal is to continue in 2023 what the FOMC started so successfully in 2022 by keeping the economy on a below-potential growth path in order to steadily but gently rebalance the labor market, which should in turn create the conditions for inflation to take hold at 2%.”
Fed officials have indicated that there is still a long way to go before they are convinced that inflation will stabilize at this level. Mericle said a “substantial rebalancing of the labor market” will be needed as the gap between jobs and workers is still about 3 million higher than its pre-pandemic level.
This will require a slower growth path for some time. Goldman expects a 25 basis point hike on Wednesday, followed by two more hikes of the same magnitude in March and May – in steps that would take the target federal funds rate to a high of between 5% and 5.25 %.
“Fewer hikes may be needed if the recent weakening in business confidence captured by survey data depresses hiring and investment more than we think, replacing additional rate hikes,” he said. said, Mericle.
“But further hikes may be needed if the economy picks up as the drag on growth from past fiscal and monetary tightening fades.”
Uncertainty over the pace of growth could lead the Fed to “recalibrate” and end up in a “stop-and-go” configuration on rates later in the year, he suggested.
The ECB telegraphed a 50 basis point hike for Thursday and vowed to stay the course on fighting inflation, but uncertainty remains around the future path of rates.
Eurozone inflation fell for a second consecutive month in December, while Tuesday revealed the bloc’s economy unexpectedly grew by 0.1% in the fourth quarter of 2022, curbing recession fears.
The anticipated half-point increase will take the ECB’s deposit rate to 2.5%. The Board of Governors is also expected to detail plans to reduce its APP (asset purchase program) portfolio by a total of 60 billion euros ($65 billion) between March and June.
In a Tuesday note, Berenberg forecast that the ECB will “probably” confirm its earlier forecast for another 50 basis point hike in mid-March, followed by further tightening in the second quarter.
The German investment bank pointed out that, although there are positive signs of headline inflation, the more rigid core inflation – which stood at 5.2% in December – has not yet reached its maximum.
“We expect the ECB to leave open the size and number of its moves in the second quarter. and principal refinancing to highs of 3.25% and 3.75%, respectively, on May 4 are trending higher,” said Berenberg chief economist Holger Schmieding.
“In line with the ECB’s recent mantra ‘higher for longer’, ECB President Christine Lagarde is likely to push back on market expectations that the bank will start cutting rates again later this year or early next year. 2024.”
By slowing its rate hikes from 75 basis points to 50 basis points in December, the ECB spooked markets by saying that rates would have to “rise significantly at a steady pace to reach sufficiently restrictive levels”. Schmieding said this sentence would be one to watch on Thursday:
“The ECB will likely confirm that it is moving at a ‘steady pace’ (read: 50bp in March and possibly beyond) without first committing to a 25bp or 50bp move in May,” he said. Schmieding said.
“But as rates will now be 50 basis points higher than at the last ECB press conference, doves might suggest the ECB should now use a slightly looser term than ‘significantly’.”
The Bank of England
A key distinction between the task of the Bank of England and that of the Fed and ECB is the continued bleak outlook for the UK economy.
The Bank had previously predicted the UK economy was entering its longest recession on record, but GDP unexpectedly rose 0.1% in November after also beating expectations in October, suggesting the recession could not be as deep as promised.
However, the International Monetary Fund on Monday lowered its projection for UK GDP growth in 2023 to -0.6%, making it the worst-performing major economy in the world, behind even Russia.
Most economists anticipate a split decision in the Monetary Policy Committee for another 50 basis point hike on Thursday – taking the key rate to 4% – but expect a more dovish tone than in recent meetings.
Barclays expects a 7-2 split vote in favor of a “strong” 50bps final hike, with communications pointing to a cut to 25bps in March.
“This may be signaled by removing or softening the ‘hard’ component of the forecast. Such an adjustment would be consistent with our call for two recent 25 basis point hikes in March and May, bringing the terminal rate to 4 .5%,” analysts for the British lender said in a note on Friday.
Victoria Clarke, UK chief economist at Santander CIB, expects a much closer 5-4 majority in the MPC in favor of the 50bp hike, with the four dissenters split between ‘no change’ and a hike of 25 basis points. She said the Bank had “no easy options”.
“Given the concern over the damage that embedded inflation would cause, we believe that a majority of the MPC will view an increase in the bank rate to 4.00% as prudent risk management, but we do not believe still not that he wants to raise the bank rate much above that,” Clarke said in a note Friday.
Santander expects a ‘double but accommodative rise’ in February and March, and Clarke suggested Governor Andrew Bailey is ‘optimistically’ watching lower headline inflation while growing increasingly worried about the outlook of the UK property market.