Central banks around the world have now sent a clear message to markets: tighter policy is here to stay.
A screen displays the Fed 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, bank of england Y Swiss National Bank all raised interest rates by 50 basis points this week, in line with expectations, but markets are honing in on their changing tones.
The markets reacted negatively after the The Fed raised its benchmark rate by 50 basis points on Wednesday to its highest level in 15 years. This marked a slowdown from the previous four meetings, in which the central bank implemented increases of 75 basis points.
However, Fed Chairman Jerome Powell noted that despite recent signs that inflation may have peaked, the fight to bring it back to manageable levels is far from over.
“There really is an expectation that services inflation won’t come down as fast, so we’ll have to stay that way,” Powell said at a news conference on Wednesday.
“We may have to increase rates more to get to where we want to go.”
On Thursday, the The European Central Bank did the same.which also opted for a smaller increase but suggested it would need to raise rates “significantly” more to control inflation.
the The Bank of England also implemented a half point hikeadding that it would “respond strongly” if inflationary pressures start to look more persistent.
George Saravelos, head of currency research at Deutsche Bank, said major central banks had given markets a “clear message” that “financial conditions must remain tight.”
“We wrote in early 2022 that the year was about one thing: raising real rates. Now that central banks have achieved this, the theme for 2023 is different: prevent the market from doing the opposite,” Saravelos said.
“Buying risky assets on the premise of weak inflation is a contradiction in terms: the accompanying easing of financial conditions undermines the very argument for weakening inflation.”
In that context, Saravelos said, the explicit shift of the ECB and Fed’s focus from the consumer price index (CPI) to the labor market is notable, as it implies that the movements of goods on the supply side are not enough to declare “mission accomplished”. “
“The overall message for 2023 seems clear: central banks will push back riskier assets until the labor market starts to turn,” Saravelos concluded.
Economic Outlook Adjustments
The hawkish messages from the Fed and the ECB somewhat surprised the market, even though the policy decisions themselves were in line with expectations.
Berenberg on Friday adjusted his terminal rate forecasts in line with developments in the past 48 hours, adding an additional 25 basis point rate hike for the Fed in 2023, taking the peak to a range between 5% and 5.25% on the during the first three meetings of the year.
“We continue to think that a decline in inflation to 3% and a rise in unemployment well above 4.5% by the end of 2023 will eventually trigger a shift to a less restrictive stance, but for now, the Fed clearly intends to go higher,” said Berenberg chief economist Holger Schmieding.
The bank also raised its projections for the ECB, which now expects to raise rates to “tight levels” at a steady pace for more than one meeting to come. Berenberg added an additional 50 basis point move on March 16 to his existing 50 basis point anticipation on February 2. This brings the ECB’s main refinancing rate to 3.5%.
“However, starting at such a high level, the ECB will likely need to cut rates again once inflation has fallen to close to 2% in 2024,” Schmieding said.
“We now expect two cuts of 25bp each in mid-2024, leaving our call for the ECB’s main refinancing rate at the end of 2024 unchanged at 3.0%.”
The Bank of England was slightly more dovish than the Fed and ECB and future decisions will likely depend heavily on how the expected UK recession plays out. However, the Monetary Policy Committee has repeatedly signaled caution about the tightness of the labor market.
Berenberg expects a further 25 basis point hike in February to bring the bank rate to a maximum of 3.75%, with 50 basis points of cuts 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, additional 25bp rate hikes by the Fed and BoE do not make a material difference to our economic outlook,” Schmieding explained.
“We still expect the US economy to contract 0.1% in 2023, followed by 1.2% growth in 2024, while the UK is likely to hit a recession with a 1.1% drop. of GDP in 2023, followed by a rebound of 1.8% in 2024”.
However, for the ECB, Berenberg sees the additional 50 basis points expected from the ECB as having a visible impact, constraining growth most evidently in late 2023 and early 2024.
“While we leave our estimate of real GDP for next year unchanged at -0.3%, we lowered our estimate of the pace of economic recovery in 2024 from 2.0% to 1.8%,” Schmieding said.
However, he noted that, over the course of 2022, central banks’ forward-looking guidance and changes in tone have not proven to be a reliable guide to future policy action.
“We view the risks to our new Fed and BoE forecasts as balanced either way, but given that the Eurozone winter recession will likely be deeper than the ECB projects, and given that inflation will likely fall substantially Starting in March, we think I see a good chance that the final ECB rate hike in March 2023 will be 25bps instead of 50bps,” he said.