In a momentous juncture for global monetary policy, the central banks of major economies are approaching, if not already teetering at, the summit of their interest rate hiking endeavours. A cacophony of signals and forecasts from these influential institutions has stirred waves of speculation and debate among economists and market observers alike.
The European Central Bank (ECB) recently thrust itself into the spotlight by embarking on an unprecedented hike, pushing its key rate to a historic pinnacle of 4%. The pivotal decision followed extensive deliberations revolving around updated projections for inflation and economic growth. Though the ECB refrained from categorically ruling out further rate hikes, its accompanying statement was unequivocal in asserting that current rates, if “maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”
However, the immediate inflation outlook remains disheartening, casting a shadow of apprehension over households. ECB staff projections now anticipate euro area inflation to average 5.6% this year, a marginal increase from the prior forecast of 5.4%, and 3.2% for the next year, up from a previous estimate of 3%. Conversely, the highly scrutinised metric for 2025 has been cautiously adjusted downwards, settling at 2.1% from a prior projection of 2.2%.
Economists, including the discerning Holger Schmieding of Berenberg, swiftly shifted their discourse towards the duration of this rate plateau. Analysts at Deutsche Bank chimed in, predicting no further cuts until September 2024, thereby implying a 12-month hiatus at the 4% level.
Nevertheless, looming uncertainties persist, prominently among them the spectre of surging oil prices. Recent crude futures ascensions to a 10-month peak could potentially reverberate throughout Europe and the U.S., impacting both goods prices and inflation expectations.
Raphael Thuin, the sagacious head of capital markets strategies at Tikehau Capital, cautioned that, despite the consensus forming around the conclusion of the ECB’s hiking cycle, “an alternative and less optimistic scenario remains possible: inflation is surprisingly strong and resilient, and appears to be structural.” Thuin astutely added, “Recent disinflationary factors (goods and commodity prices) seem to be running out of steam… There is a risk that, in the absence of a more convincing downward trend in prices, the ECB will consider its battle against inflation unfinished, with the risk of further rate hikes on the horizon.”
The Federal Reserve’s posture on interest rates has also garnered substantial attention, as Fed Chair Jerome Powell recently emphasised the prospect of additional hikes. The central bank harbours deep concerns over a potential resurgence of inflation if financial conditions ease. In its June forecast, not set in stone and liable for revision this week, the Fed did not foresee inflation reaching 2.1% until 2025.
Monthly data has consistently shown persistent price pressures. The consumer price index, driven primarily by energy prices, surged in August, attaining its fastest monthly rate this year at 3.7% year-on-year. Core inflation, a critical metric, settled at 0.3% on a monthly basis and 4.3% annually. Producer price inflation exhibited its most substantial monthly gain since June 2022.
However, while markets remain almost certain that the U.S. Federal Reserve will maintain rates in September, opinions diverge on the likelihood of another hike this year. A Reuters poll of economists revealed that 20% anticipate at least one additional hike.
Economists at J. Safra Sarasin assert that “Given the relatively strong economic data and sticky inflation, [the Fed] will maintain a hawkish bias.” They further contend that the Federal Open Market Committee “will probably leave a final hike by year-end in its updated dot plot,” referencing the interest rate projections released quarterly by Fed policymakers.
Expectations for the Bank of England are perched on the precipice of one last hike in September, amidst an inflation rate of 6.8% and emerging signs of economic strain, with talk of a “mild recession” rekindling. The Monetary Policy Committee, in its August report, projected inflation to reach 5% by year-end, halving by the close of the next year and converging towards its 2% target by early 2025.
However, Marcus Brookes, the chief investment officer at Quilter Investors, aptly noted that the Bank of England is no longer operating within the realm of unequivocal necessity for interest rate hikes. Brookes cited weak gross domestic product data for July as a compelling factor.
Analysts at BNP Paribas anticipate a final “dovish hike” in September, citing the confluence of wage growth and inflation pressures alongside indicators of softening economic activity. Wage growth figures, holding steady at 7.8% for May to July, remain at record highs, but signs of a cooling job market have surfaced, with a 0.5 percentage point rise in unemployment during the same period.
In addition, the mortgage market exhibits vulnerability, with payments in arrears surging to a seven-year high in the three months to June. ING’s developed markets economist, James Smith, underscored the downtrend in expected price growth and wage growth, coupled with a diminishing struggle to find staff reported by fewer firms. Smith opined that “a November hike is possible, but assuming we’re right about the direction of the dataflow and on the basis of recent BoE comments, we think a pause is still more likely at that meeting.”
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