The central banks will signal the rate glide path in a crucial week
A monitor shows the Fed interest 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 and the Bank of England are all expected to raise interest rates again this week, when they make their first policy announcements of 2023.
Economists will be watching politicians̵[ads1]7; rhetoric closely for clues about future rate hikes this year, as the three major central banks try to engineer a soft landing for their respective economies without allowing inflation to pick up again.
All three banks are expected to highlight commitments to return inflation to targets close to 2%, but recent positive data has led to hope that central banks will eventually be able to slow the pace of rate hikes.
Nick Chatters, head of fixed income at Aegon Asset Management, said the task for market watchers is to “telegraphically infer” from this week’s press conferences what Fed Chairman Jerome Powell and ECB President Christine Lagarde think about the “terminal rate” and how long they intend to keep monetary policy restrictive until they begin to normalize.
The Federal Open Market Committee concludes its meeting on Wednesday, before the Bank of England and ECB deliver their decisions on Thursday.
Since the FOMC’s December meeting, economic data showing an easing of wage growth and inflationary pressures, along with some more activity growth signals, have strengthened the case for the Fed to adopt a 0.25 percentage point rate hike – a marked downgrade from the jumbo moves seen. in 2022.
The market is now pricing in this case, but the key question is what the FOMC will indicate about further rate hikes in 2023.
“We think the Fed’s path this year is best thought of in terms of a target to be achieved rather than a target level of the funds rate to be reached,” Goldman Sachs US Chief Economist David Mericle said in a note on Friday.
“The goal is to continue in 2023 what the FOMC started so successfully in 2022 by keeping the economy on a growth path below potential growth in order to steadily but gently rebalance the labor market, which in turn should create the conditions for inflation to settle sustainably at 2%. “
Fed officials have indicated that there is still some way to go before they are confident that inflation will settle at this level. Mericle said significant “rebalancing of the labor market” will be needed, as the gap between jobs and workers remains about 3 million above pre-pandemic levels.
This will necessitate 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 scale in March and May – in steps that would take the target Fed funds rate to a peak of between 5% and 5.25%.
“Fewer increases may be needed if the recent weakening in business confidence captured by the survey data depresses hiring and investment more than we think, displacing further rate hikes,” Mericle said.
“But more increases may be needed if the economy re-accelerates as the drag on growth from past fiscal and monetary policy tightening eases.”
The uncertainty over the pace of growth could cause the Fed to “recalibrate” and find itself in a “stop-and-go” pattern on interest rates later in the year, he suggested.
The ECB has telegraphed a 50 basis point hike for Thursday and vowed to stay on course to tackle inflation, but uncertainty remains over the future path of interest rates.
Eurozone inflation fell for a second straight month in December, while on Tuesday it revealed the bloc’s economy unexpectedly expanded by 0.1% in the fourth quarter of 2022, easing recession fears.
The expected half-point increase would bring the ECB’s deposit rate to 2.5%. The governing council is also expected to detail plans to reduce its asset purchase program (APP) portfolio by a total of 60 billion euros ($65 billion) between March and June.
In a Tuesday note, Berenberg estimated the ECB would “likely” confirm its previous guidance for another 50 basis point hike in mid-March, followed by further tightening in the second quarter.
The German investment bank highlighted that while there are positive signs in headline inflation, stickier core inflation – which came in at 5.2% in December – has yet to peak.
“We expect the ECB to leave open the size and number of its moves in Q2. The risk to our call for only one final rate hike of 25bp in Q2 to take deposit and main refinancing rates to peaks of 3.25 % and 3.75% May 4 has been tilted up, says chief economist Holger Schmieding in Berenberg.
“In line with the ECB’s recent ‘higher for longer’ mantra, ECB President Christine Lagarde is likely to push back against market expectations that the bank will start cutting rates again late this year or early 2024.”
After slowing rate hikes from 75 basis points to 50 basis points in December, the ECB spooked markets by claiming that interest rates would have to “rise significantly at a steady pace to reach levels that are sufficiently restrictive.” Schmieding said this sentence will be one to watch on Thursday:
“The ECB is likely to confirm that it is moving at a ‘steady pace’ (read: 50bp in March and possibly beyond) without pre-committing to either a 25bp or 50bp move in May,” Schmieding said.
“However, as interest rates will now be 50bp higher than at the previous ECB press conference, the doves may suggest that the ECB should now use a slightly softer term than ‘significant’.”
Bank of England
A key difference between the Bank of England’s remit and those of the Fed and ECB is the persistently bleak outlook for the UK economy.
The bank previously predicted the UK economy was entering its longest ever recession, but GDP unexpectedly grew by 0.1% in November after also beating expectations in October, suggesting the recession may not be 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, behind even Russia.
Most economists expect a split decision among the monetary policy committee in favor of another 50 basis point hike on Thursday – taking the Bank’s interest rate to 4% – but expect a more dovish tone than in recent meetings.
Barclays expects a split vote of 7-2 in favor of a final “strong” increase of 50 basis points, with communications forecasting a move down to 25 basis points in March.
“This could be signaled by removing, or softening, the ‘strong’ component of the forward guidance. Such an adjustment would be consistent with our call for two recent 25bp hikes in March and May, taking the terminal rate to 4.5%, ” analysts at the British lender said in a note on Friday.
Victoria Clarke, UK chief economist at Santander CIB, expects a much closer 5-4 majority in the MPC in favor of a 50 basis point increase, with the four dissenters split between “no change” and a 25 basis point increase. She said the bank has no easy options.
“Given the concern over the damage built-in inflation will cause, we think a majority of the MPC will consider an increase in the Bank Rate to 4.00% as prudent risk management, but we still do not think they want to take the Bank Rate much above this,” Clarke said in a note Friday.
Santander expects a “double but dovish rise” in February and March, and Clarke suggested Governor Andrew Bailey is “optimistic” about falling headline inflation, while growing concerned about the outlook for the UK housing market.