A screen shows the Fed’s interest rate announcement as a trader works on the floor of the New York Stock Exchange (NYSE) on November 2, 2022.
Brendan McDermid | Portal
The US Federal Reserve, European Central Bank and Bank of England are all expected to hike rates again this week as they make their first policy announcements for 2023.
Economists will be watching policymakers’ rhetoric closely for clues as to the trajectory of future rate hikes this year as the big three central banks attempt to secure a soft landing for their respective economies without inflation resuming.
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All three banks are expected to reiterate their commitments to returning inflation towards targets close to 2%, but recent positive data has fueled hopes that central banks will eventually be able to step up the pace of rate hikes slow it down.
Nick Chatters, fixed income manager at Aegon Asset Management, said the market watchers’ job is to “telegraphically infer” from this week’s press briefings what Fed Chair Jerome Powell and ECB President Christine Lagarde think about the “final rate” and how long do they intend to keep monetary policy tight before they start to normalize.
The Federal Open Market Committee concludes its meeting on Wednesday before the Bank of England and the ECB announce their decisions on Thursday.
the fed
Since December’s FOMC meeting, economic data showing a slowdown in wage growth and inflationary pressures, along with some other worrying signals for activity growth, have strengthened the case for a 0.25pp rate hike by the Fed – a sharp downside move from observed Jumbo movements in 2022.
The market is now pricing in that eventuality, but the key question is what the FOMC will announce about further rate hikes in 2023.
“We believe the Fed’s trajectory this year is best thought of in terms of a target to be reached, rather than a rate level to be reached,” Goldman Sachs chief economist David Mericle said in a statement on Friday.
“The aim is to continue in 2023 what the FOMC so successfully started in 2022, by keeping the economy on a growth path below potential, to steadily but gently rebalance the labor market, which in turn will set the conditions for a sustainable Inflation should calm down by 2%.”
Fed officials have indicated there is still a long way to go before they are confident that inflation will settle at these levels. Mericle said significant “job market rebalancing” will be required as the job-to-worker gap is still around 3 million above pre-pandemic levels.
This will require a slower growth path for a while longer. 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 Fed’s target rate to a high of between 5% and 5.25%.
“Fewer rate hikes may be needed if the recent weakening in business confidence, as captured by survey data, weighs on hiring and investment more than we think and replaces additional rate hikes,” Mericle said.
“But further rate hikes may be needed if the economy picks up speed again as the drag on growth from past fiscal and monetary tightening eases.”
Uncertainty about the pace of growth could prompt the Fed to “recalibrate” and find itself in a “stop-and-go” pattern on interest rates later in the year, he suggested.
The ECB
The ECB cabled a 50 basis point hike for Thursday and promised to stay on course in fighting inflation, but future interest rate developments remain uncertain.
Eurozone inflation eased for a second straight month in December, while Tuesday revealed the bloc’s economy had grown unexpectedly by 0.1% in the fourth quarter of 2022, dampening recession fears.
The expected half-point hike will bring the ECB’s deposit rate to 2.5%. The Governing Council is also expected to outline plans to reduce its APP (asset purchase program) portfolio by a total of 60 billion euros ($65 billion) between March and June.
In a note on Tuesday, Berenberg predicted that the ECB would be “likely” to confirm its earlier forecast of another 50 basis point hike in mid-March, followed by further tightening in the second quarter.
The German investment bank stressed that while there are positive signs for headline inflation, stubborn core inflation – which stood at 5.2% in December – has not yet peaked.
“We assume that the ECB will leave open the scope and number of its moves in the second quarter. The risks of our call for just one final 25 basis point rate hike in the second quarter will push deposit and main refinancing rates to peak at 3.25% and 3.75% respectively, on May 4 are tilted higher,” Berenberg’s chief economist said Holger Schmieding.
“In line with the ECB’s recent mantra ‘higher for longer,’ ECB President Christine Lagarde is likely to go against market expectations that the bank will start cutting rates again later this year or early 2024.”
As the ECB slowed rate hikes from 75 basis points to 50 basis points in December, it spooked markets by claiming that rates would “need to rise significantly at a steady pace to reach sufficiently restrictive levels”. Schmieding said this sentence will be looked at on Thursday:
“The ECB is likely to confirm that it is moving at a ‘steady pace’ (read: 50 basis points in March and possibly beyond) without committing to a 25 basis point or 50 basis point move in May,” Schmieding said.
“But with rates now set to be 50 basis points higher than at the last ECB press conference, the doves could suggest that the ECB should now use a slightly softer term than ‘clear’.”
The Bank of England
A key difference between the Bank of England’s responsibilities and those of the Fed and ECB is the continued bleak outlook for the UK economy.
The bank previously forecast the UK economy to enter its longest recession on record, but GDP grew unexpectedly by 0.1% in November after also beating expectations in October, suggesting the recession may be over not as deep as promised.
However, the International Monetary Fund on Monday downgraded its forecast for UK GDP growth in 2023 to -0.6%, making it the world’s worst-performing major economy, even behind Russia.
Most economists are expecting a split decision from the Monetary Policy Committee in favor of another 50 basis point hike on Thursday – bringing the key rate to 4% – but expect a more dovish tone than in recent meetings.
Barclays expects a 7-2 split for a final “powerful” 50 basis point rise, with the releases heralding a move down to 25 basis points in March.
“This can be signaled by removing or weakening the ‘powerful’ component of forward guidance. Such an adjustment would match our call for two final 25bp hikes in March and May, bringing the final rate to 4.5%. Analysts at the UK lender said in a note on Friday.
Victoria Clarke, UK Chief Economist at Santander CIB, expects a much tighter 5-4 majority in the MPC in favor of the 50bp hike, with the four dissenters split between no change and a 25bp hike. She said the bank had “no easy options”.
“Given concerns about the damage embedded inflation would cause, we believe a majority of the MPC will view raising interest rates to 4.00% as prudent risk management, but we still don’t believe it will take interest rates far want to raise above that,” Clarke said in a note on Friday.
Santander expects a “double but cautious rate hike” in February and March, and Clarke indicated that Governor Andrew Bailey was “optimistic” about falling headline inflation as he grew concerned about the prospects for the UK housing market.