- After the European Central Bank raised interest rates to a record 4%, economists said they were likely to have peaked, with the question now becoming how long they will stay at that level .
- Both the Federal Reserve and the Bank of England should consider at most one more hike, but they should stop there.
- However, inflation is not expected to reach central banks’ 2% target until 2025, meaning further hardship for households and risks to the outlook.
Christine Lagarde, President of the European Central Bank (ECB), during a press conference on the rate decision in Frankfurt, Germany, Thursday, September 14, 2023. The ECB raised interest rates again, acting for the 10th consecutive time to stifle inflation. of the increasingly weak eurozone economy.
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It is now widely accepted that the central banks of some of the world’s largest economies have reached, or are close to reaching, the highest level they will accept on interest rates.
The European Central Bank said last week that its Governing Council believed rates may have reached their level.
After lengthy deliberations over its updated forecasts for inflation and economic growth and what they should mean for monetary policy, the ECB raised its key rate to a record 4%. Although the accompanying statement in no way rules out further increases, it does indicate that rates are at levels which, if sustained for a sufficiently long period, will make a substantial contribution to the rapid return of l inflation towards the target.
The short-term inflation outlook remains gloomy and is expected to hit households hard. ECB staff macroeconomic projections for the euro area now forecast average inflation of 5.6% this year, up from a previous forecast of 5.4%, and 3.2% next year, up from a previous forecast by 3%.
But the forecast for 2025, one of the most closely watched indicators measuring the medium-term outlook, was revised downwards from 2.2% to 2.1%.
The discussion will now turn to how long rates will remain stable at the current level, economists including Berenberg’s Holger Schmieding said after the announcement.
Analysts at Deutsche Bank said they do not expect any cuts until September 2024, implying a 12-month break at 4%.
Challenges remain, however, one of them being the prospect of a significant rise in oil prices. Crude futures recently hit a 10-month high, which could impact goods costs and inflation expectations in Europe as well as the United States.
Raphael Thuin, head of capital markets strategies at Tikehau Capital, said that despite the consensus around the end of the ECB’s hiking cycle, “an alternative and less optimistic scenario remains possible: inflation is surprisingly strong and resilient , and seems structural”.
“Recent disinflationary drivers (goods and commodity prices) appear to be running out of steam… There is a risk that in the absence of a more convincing downward price trend, the ECB will consider its battle against inflation as unfinished, with the “There is a risk of further rate hikes on the horizon,” Thuin said in a note.
“In this regard, the development of macroeconomic data over the coming weeks will be decisive.”
Fed Chairman Jerome Powell made clear last month that further hikes were on the table, and the central bank is deeply concerned about further acceleration in inflation if financial conditions ease.
In its June forecast, which will likely be revised this week in an updated projection, it does not expect inflation to reach 2.1% until 2025.
Monthly data shows persistent price pressures. The consumer price index rose at its fastest monthly pace this year in August, mainly driven by energy prices, and stood at 3.7% year-on-year. Core inflation stood at 0.3% on a monthly basis and 4.3% on an annual basis, while producer price inflation recorded the largest monthly increase since June 2022 .
But markets are almost certain that the US Federal Reserve will keep rates unchanged in September and are divided on whether a further hike will be implemented this year. In a Reuters poll of economists, 20% expected at least one.
“Given relatively strong economic data and persistent inflation, [the Fed] will maintain a hawkish bias,” economists at J. Safra Sarasin said in a note.
The Federal Open Market Committee “will likely leave one final hike by the end of the year in its updated dot plot, although we don’t think it will ultimately follow through.” The dot plot refers to interest rate projections released quarterly by Fed policymakers.
Markets continue to expect the Fed to cut rates next year, although some say it could be premature. In the same Reuters poll, 28 economists expected a first reduction in the first quarter, while 33 anticipated it in the second quarter.
The Bank of England expects a final hike in September as it weighs on inflation of 6.8%, with signs of strain on the economy and renewed talk of a “mild recession”.
In its August report, the Monetary Policy Committee said it expected inflation to reach 5% by the end of the year, halving by the end of next year and reaches its target of 2% at the start of 2025.
“The Bank is no longer in a clear zone where interest rate hikes are unequivocally necessary,” said Marcus Brookes, investment director at Quilter Investors, highlights the weak gross domestic product data for July.
Analysts at BNP Paribas said they expected a final “accommodative increase” in September, as wage growth and inflationary pressures combine with a slowdown in activity indicators.
Wage growth figures for the May-July period remained stable at 7.8%, maintaining their record level, but there were also signs of a slowdown in the jobs market, with unemployment rising by 0.5 percentage points over the same period.
The mortgage market is another weak spot, with delinquent payments hitting a seven-year high in the three months to June.
James Smith, developed markets economist at ING, noted that expected price growth and wage growth had both declined, while fewer companies reported difficulty finding staff.
“A hike in November is possible, but assuming we are right about the direction of the data flow and based on recent comments from the BoE, we think a pause is even more likely at this meeting,” Smith said.