The latest from the World Economic Forum Perspectives of leading economists highlighted the uncertain backdrop to this week’s US Federal Reserve and European Central Bank meetings. While 45% of economists thought a global recession was likely this year, the same percentage thought it unlikely. A lack of clarity about the trajectory of the US and Eurozone economies prevails.
The Fed is trying to assess the impact of instability in US regional banks; the ECB is attempting to assess how well its previous rate hikes are doing. Both called for caution. The Fed hiked rates another 25 basis points, signaling a potential pause for thought. The ECB also raised rates by a quarter of a point, a smaller increase than in the past, pending further data. While inflation has yet to be defeated, in turbulent times these were sensible decisions.
Markets had expected the Fed’s rate-hiking cycle to peak just above 5%, as it had signaled. Underlying inflation in America, excluding energy and food, remains elevated at around 5.6%. But it weighed against turmoil in the banking sector, tighter lending conditions and nascent signs of a cooling in the Job market in the United Statest, raising interest rates to a target range of 5% to 5.25% while outlining a wait-and-see approach on subsequent decisions made sense. Indeed, the The statement from the Fed raised the bar for further “political strengthening”, without ruling it out.
With inflation still high, the Fed was right to keep the door open. But traders were looking for clues as to when it will start cutting rates. Chairman Jay Powell reiterated the Fed’s willingness to keep rates higher for longer, but markets are still pricing in cuts this year. He may have preferred that investors interpret his post-meeting comments as more aggressive. If high inflation persists, a major revision of market rate expectations could be in store.
While the end of rate hikes is easier to predict in the US, it’s not quite in sight for the Eurozone. Inflation pushed back at 7% last month and the job market remains fiery. More rate hikes are needed. There has been some debate as to whether this week’s 25 basis point hike to 3.25% should have been as 50 basis points as at the previous meeting, but recent data suggests a slowdown in the pace of rate hikes has been wise. ECB investigations show a slowdown in bank lending and weaker credit demand. With evidence that previous rate hikes are having an impact, a larger hike would have been bold. Instead, President Christine Lagarde has implemented a hawkish slowdown: the ECB still has “more ground to cover”, but it is important to assess how fast it needs to get there.
The historic cycle of central bank rate hikes may be near or at its peak, but it is right for central bankers to keep their options open. Investors expect the Bank of England will also raise rates by 25 basis points next week. With inflation still in double digits, it could also leave the prospect of further hikes on the table. High inflation should not be allowed to consolidate, but with the steep rise in the cost of credit over the past year it is only right that central bankers now fine-tune their rate path as more data arrives.
Some might argue that with inflation still above target, monetary policy makers cannot afford to wait. But as global inflationary forces ease, the overall trajectory of inflation is downwards. Higher rates are starting to tighten lending in the US and Europe, which central banks hope will fuel lower wage growth. Concerns about the US debt ceiling, banking turmoil and vulnerabilities in the non-bank sector also persist. With the economic fog thickening and a lot of the heavy lifting already done by central banks, now is the right time to start taking stock.
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