Central bank trio hikes rates as hawks and doves jostle for position
After simultaneous 50 basis point rate rises in the US, Europe and the UK, we look at the different outlooks and circumstances the respective central banks face.
The triumvirate of the Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) all raised their respective policy interest rates by 0.50% in the past 24 hours in the ongoing tightening of monetary policy to lower inflation.
Our economists share their views on the moves.
Azad Zangana, Senior European Economist and Strategist:
"Both the ECB and BoE slowed their pace of hiking (from 0.75%), but matched market expectations. The pair remain concerned over the risk of higher inflation and more hikes are planned, but there are some subtle differences in the outlook going forward.
ECB hawks take back control
"The ECB raised all three of its main policy rates, taking the main refinancing rate up to 2.5%. Although the ECB delivered a smaller rate rise than its previous two hikes, the tone from the bank has once again turned hawkish. In its press conference, president Lagarde stated that further significant hikes would be necessary to normalise inflation. This may have been in reaction to the new ECB staff projections, which have once again revised up the forecast for inflation in coming years.
"Money markets had priced the peak in the main ECB interest rate to reach between 2.75% and 3% early next year. However, the signal from the ECB seems to suggest that the terminal rate may now need to be higher given the worsening outlook for inflation.
"The ECB also announced that from March 2023, it would allow some of the assets owned from its quantitative easing programme (QE) to mature without replacement. This is expected to lower the size of its balance sheet by €15 billion per month until the end of the second quarter of the year, where the committee will then re-assess the rate of run-off. This was largely expected and brings the ECB in line with the BoE and the Fed in starting quantitative tightening, to reduce liquidity as interest rates are raised.
BoE doves starting to coo
"Meanwhile, the BoE raised its main policy interest rate from 3% to 3.5%, also slowing the pace of hikes, and in contrast with the ECB, its voting suggested that the monetary policy committee (MPC) was turning more dovish. Three of the nine-member committee dissented, with one voting for a larger rise to 3.5%, but two voting for no change at all (3%). These two more dovish members had previously voted for smaller rate rises, but their new votes hint that the BoE could be close to completing its tightening of policy. They pointed out that the real economy remained weak and that signs of a slowdown in the labour market had started to appear.
"The minutes from the MPC meeting suggest that the outlook for growth and inflation was largely unchanged, although recent outturns for the latter had been lower than previously forecast. The government’s Autumn (fiscal) Statement is expected to raise growth in the near-term, but lower inflation thanks to the energy price guarantee.
Diverging signals move market expectations
"While the policy action today was almost identical between the ECB and BoE, the difference in tone pushed markets in opposite directions. In particular government bond markets which are highly influenced by the path of policy interest rates.
"The more dovish BoE helped lower gilt yields across the curve along with the pound, both against the euro and US dollar.
"Meanwhile, the more hawkish tone from the ECB prompted a more significant sell-off in eurozone government bonds, pushing yields higher. For example, the 2-year German government bond (Schatz) yield rose 24 basis points. The euro also rose against both the pound and US dollar."
Fed slows pace of hikes, but stays hawkish
Keith Wade, Chief Economist, said:
"As expected, the Fed moved by 50 bps to take the Fed funds rate to 4.5% (upper bound). The move was very much in line with the messaging from chair Powell in the run-up to the meeting.
"The surprise came in the “dot plot”, the projections of FOMC members for the Fed funds rate, which showed only 2 of the 19 participants expecting rates to be below 5% at the end of next year. The median view was no rate cuts next year, with the risk that rates go higher. This is at odds with the market, which is looking for an easing of policy later in 2023.
"Looking at the economic projections, the Fed is looking for a similar fall in inflation as consensus, but with less weakness in growth and employment. More of a soft landing.
"Our view is that a bigger fall in activity is needed to bring down inflation. This is still likely and we continue to forecast a US recession next year creating an environment where it would be hard for the Fed not to ease"
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
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