A screen shows the Fed rate announcement as a trader works on the floor of the New York Stock Exchange (NYSE), November 2, 2022.
Brendan McDermid | Reuters
The US Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank all raised interest rates by 50 basis points this week, in line with expectations, but markets are playing to their mixed tones.
Markets reacted negatively after the Fed raised its benchmark rate by 50 basis points on Wednesday to the highest level in 15 years. This marked a slowdown from the previous four meetings, at which the central bank raised 75 basis points.
However, Fed Chairman Jerome Powell indicated that, despite recent indications that inflation may have peaked, the battle to wrestle it back to manageable levels is far from over.
“There’s really an expectation that services inflation won’t come down that fast, so we’re going to have to stick with it,” Powell said at Wednesday’s news conference.
“We may have to raise rates to get where we want to go.”
On Thursday, the European Central Bank followed suit and also opted for a smaller hike, but suggested it would need to raise rates “significantly” further to contain inflation.
The Bank of England also implemented a half-point increase, adding that it would “react strongly” if inflationary pressures appear more persistent.
George Saravelos, head of FX research at Deutsche Bank, said major central banks had given markets a “clear message” that “financial conditions must remain tight”.
“We wrote at the beginning of 2022 that the year was all about one thing: rising real interest rates. Now that central banks have achieved this, the theme for 2023 is different: preventing the market from doing the opposite,” said Saravelos.
“Buying risky assets based on weak inflation is a contradiction in terms: the easing of financial conditions that it entails actually undermines the argument of weakening inflation.”
In that context, Saravelos said, the explicit shift in focus of the ECB and the Fed from the consumer price index (CPI) to the labor market is noteworthy, as it implies that movements on the supply side of goods are not enough to explain that the mission is accomplished. “
“The overall message for 2023 seems clear: central banks will reduce riskier assets until the labor market starts to turn around,” concludes Saravelos.
Economic outlook tweaks
The aggressive reporting from the Fed and the ECB surprised the market somewhat, even though the policy decisions themselves were in line with expectations.
Berenberg on Friday adjusted its final rate forecasts in line with developments over the past 48 hours, adding an additional 25 basis points to the Fed’s rate hike in 2023, pushing the peak over the year to a range of between 5% and 5.25% was charged. first three meetings of the year.
“We still think that a fall in inflation to c3% and an increase in unemployment well above 4.5% by the end of 2023 will eventually lead to a shift to a less restrictive stance, but for now the Fed is clearly intending to go higher.” said Berenberg chief economist Holger Schmieding.
The bank also raised its forecasts for the ECB, which now sees rates rising to “restrictive levels” at a steady pace for more than one upcoming meeting. Berenberg added another 50 basis point increase on March 16 to the existing 50 basis point expectation on February 2. This brings the ECB’s main refinancing rate to 3.5%.
“From such a high level, however, the ECB will probably have to cut rates again once inflation has fallen to close to 2% in 2024,” Schmieding said.
“We now look forward to two cuts of 25 bps each by mid-2024, leaving our call for the ECB’s main refi rate at the end of 2024 unchanged at 3.0%.”
The Bank of England was somewhat dovish than the Fed and the ECB and future decisions are likely to depend heavily on the course of the expected UK recession. However, the Monetary Policy Committee has repeatedly warned of tight labor markets.
Berenberg expects an additional 25 basis points hike in February to take bank rates to a peak of 3.75%, with cuts of 50 basis points in the second half of 2023 and another 25 basis points by the end of 2024.
“But against a backdrop of positive surprises in recent economic data, the additional 25 basis point rate hikes by the Fed and BoE do not make a material difference to our economic outlook,” explained Schmieding.
“We still expect the US economy to contract by 0.1% in 2023, followed by 1.2% growth in 2024, while the UK is likely to go into recession with a 1.1% decline in GDP in 2023, followed by a 1.8% recovery in 2024.”
For the ECB, however, Berenberg does see that the additional 50 basis points expected from the ECB will have a visible impact, curbing growth most clearly in late 2023 and early 2024.
“While we leave our real GDP call unchanged at -0.3% for next year, we are lowering our call for the pace of economic recovery in 2024 from 2.0% to 1.8%,” Schmieding said.
However, he noted that over the course of 2022, forward guidance and shifts in tone from central banks have not proven to be a reliable guide to future policy action.
“We see the risks to our new forecasts for the Fed and BoE as balanced in both directions, but as the winter recession in the Eurozone is likely to be deeper than the ECB forecasts, and as inflation is likely to fall significantly from March, we see a good chance that the ECB’s eventual rate hike in March 2023 will be 25bp instead of 50bp,” he said.