The Fed, BoE and ECB have their last rate setting meetings of 2023 this week, Rate cuts seem unlikely but investors will be watching closely to see what signals are being sent for the first quarter of 2024
The world’s largest central banks are gearing up for their final meetings of the year, and all eyes are on their decisions regarding interest rates.
With stubbornly high inflation and strong employment numbers, the US Federal Reserve, the European Central Bank (ECB), and the Bank of England (BoE) are expected to maintain their current high-interest rates.
Amidst soaring inflation, financial markets are anticipating interest rate cuts next year as high borrowing costs weigh on economic growth. However, the central banks are likely to adopt a cautious approach, acknowledging the progress made in reducing inflation while avoiding complacency.
According to Raphal Olszyna-Marzys, an international economist at J Safra Sarasin Sustainable Asset Management, the core message from central banks is expected to be consistent – progress has been made, but there is no room for complacency.
The central banks’ decisions will have far-reaching implications for the global economy. If interest rates remain high, economic growth may slow down, and the risk of recessions on both sides of the Atlantic could increase.
On the other hand, if rates are cut, it could stimulate economic growth but also risk exacerbating inflation. The Bank of England has already indicated that UK interest rates will need to be kept at the current level of 5.25% for an extended period due to persistently high inflation in the country.
CFOs and investors should prepare for the possibility of continued high interest rates. This could result in higher borrowing costs and potentially lower returns on investments. However, it is important to consider the potential for rate cuts next year.
Financial markets are rapidly throwing in the towel on the ‘higher for longer’ narrative that central banks have been pushing hard upon for months. So far, that market repricing has been less aggressive for the Bank of England.
Investors are expecting three rate cuts next year compared to more than five over at the ECB. The first move is seen in June, as opposed to March over in Frankfurt. Despite that more modest adjustment, the Bank of England is starting to sound the alarm.
BoE governor Andrew Bailey has repeatedly stressed that it is still too soon to start thinking about rate cuts even though inflation has started to come down. The consumer price index fell to 4.6 per cent in October – the largest monthly drop in inflation since the early 1990s. This figure was down from 6.7 per cent in September.
Richard Partington, Economics correspondent at The Guardian, notes that policymakers at the Bank of England have indicated that UK interest rates will need to be kept at the current level of 5.25% for an extended period in response to persistently high inflation, which contradicts the rate cuts anticipated by financial markets.
Julian Jessop, economics fellow at the Institute of Economic Affairs, told City A.M. that the Bank’s Monetary Policy Commitee (MPC) would “likely stick to its line that inflation is still too high and that the risks remain on the upside” at its final meeting of the year.
He added: “Rightly or wrongly, the MPC remains worried about pay pressures, and the large increases in the National Living Wage will not have helped here.”
While the chances of a surprise rate hike have gone, there’s a good chance that the three hawks on the committee once again vote for another 25 basis rate increase. The BoE will only publish a statement and minutes this month, and no press conference or forecasts, so the opportunity to shift the messaging is fairly limited.
AJ Bell analysts Russ Mould and Danni Hewson said the Bank was expected to remain in “wait-and-see mode” and leave the bank rate at 5.25%. “The outlook statements and how the balance of votes fall may therefore be more informative than the headlines,” they added.
The ECB is also expected to keep rates om hold. The question therefore will be to what extent it will align with the market’s aggressive pricing for rate cuts in 2024.
There is growing evidence that the Governing Council is split about the messaging being presented to markets. Isabel Schnabel dropped strong dovish hints by ruling out rate hikes this week, and markets are now pricing in 135 basis point of cuts in the next 12 months.
ING’s analysis see a good chance that the overall message at this meeting will fall short of endorsing aggressive rate cut expectations.
For CFOs: The ECB meeting may not align with market expectations for significant rate cuts in 2024.
The ECB’s stance is cautious due to persistent core inflation, despite dovish signals from some members. This divergence could affect the euro and financial market perceptions of ECB policy.
The Federal Reserve is widely expected to leave the fed funds target range at 5.25-5.5% at next week’s FOMC meeting. Softer activity numbers, cooling labour data and benign month-on-month% inflation prints signal that monetary policy is probably restrictive enough to bring inflation sustainably down to 2% in coming months, a narrative that is being more vocally supported by key Federal Reserve officials.
The bigger story is likely to be contained in the individual Fed member forecasts – how far will they look to back the market perceptions that major rate cuts are on their way?
The Fed last raised rates in July and there is growing evidence that tight monetary policy and restrictive credit conditions are having the desired effect on depressing inflation.
The US labour market unexpectedly strengthened in November with pickups in employment and wages; this will likely have deflated hopes for the Federal Reserve to cut interest rates early next year.
However, the Fed will not want to endorse the market pricing of significant rate cuts until they are confident price pressures are quashed.
Former Fed official Larry Summer said the central bank should wait to cut interest rates until there’s ‘overwhelming’ data to support the decision. “The moment they turn, or announce they’re going to turn, is going to be a seismic moment,” Summers told Bloomberg.
There has been a big swing in expectations for Federal Reserve policy since the last FOMC meeting, with markets firmly buying into the possibility of some aggressive interest rate cuts next year. Back on November 1, after the Fed held rates steady for the second consecutive meeting, fed funds futures priced around a 20% chance of a final hike by the December FOMC meeting with nearly 90bp of rate cuts expected through 2024.
Today, markets are clearly of the view that interest rates have peaked with 125bp of rate cuts priced through next year. Underscoring this shift in sentiment, we have seen the US 10 year Treasury yield fall from just shy of 5% in late October to a low of 4.1% on December 6th.
Goldman Sachs now projects Jerome Powell and the Fed will cut interest rates twice next year with the first cut in Q3. Goldman had previously predicted the Fed to begin cutting rates next December 2023.
But not all market participants are happy with such an approach. Ross Gerber, CEO of Gerber Kawasaki Wealth & Investment Management said “Interest rates are way too high. It’s snuffing out small businesses and will eventually cause many more bankruptcies and defaults.”
“The Fed should cut by at least 100 basis points next year. Preferably in the first half. This will protect the economy while maintaining higher rates. The market is already there anyways.”
As we enter into 2024, the consumer will be the key, and with real household disposable incomes flatlining, credit demand falling, and pandemic-era accrued savings being exhausted for many, there could be a risk of a recession during 2024.
Analysts at ING say collapsing housing transactions and plunging homebuilder sentiment suggest residential investment will weaken, while softer durable goods orders point to a downturn in capital expenditure. They not that if low gasoline prices are maintained, inflation could be at the 2% target in the second quarter of next year, which could open the door to lower interest rates from the Federal Reserve from May onwards – especially if hiring slows.
