The most aggressive central bank tightening cycle for decades is reaching its finale. Here is a definitive guide to global central banks as we enter another round of crucial meetings over the next few weeks.
There’s a growing sense that the recent banking stresses will leave their mark on the global economy, even if the acute phase of the crisis seems to be over. Cracks are starting to form in the most interest-sensitive parts of the economy after what, in many cases, has been the most aggressive central bank tightening cycle in decades. Rate cuts are on the horizon, and we expect the first central banks to start loosening policy before the end of the year.
For now though, policymakers are satisfied they have the tools available to deal with fragilities in the financial system as they emerge, thus allowing monetary policy to remain focused squarely on inflation. Expect this narrative to prevail at the upcoming central bank meetings, particularly as inflation data continues to come in uncomfortably high across major economies.
With some notable exceptions, central banks across the developed world look poised to raise rates further in the short term. That’s in contrast to Central and Eastern Europe and Asia, where policy rates have largely already peaked.
Here is our expectations for the next round of meetings, gives you the underlying rationale and, in an era of elevated uncertainty, the main risks to our calls.
Federal Reserve: James Knightley
Our call: 25bp hike in May marks the top. A six-month pause and then 50bp of rate cuts in November and December, with Fed funds hitting 3% by the second quarter of 2024.
Rationale: After the most aggressive monetary policy tightening cycle in 40 years, cracks are starting to form. The housing market is deteriorating, business sentiment is in recession territory, and recent banking stresses mean lending conditions will tighten considerably. The chances of a hard landing for the economy are rising, which will mean inflation falls more quickly. The Fed’s dual mandate of price stability and maximum employment gives it the flexibility to respond swiftly with rate cuts.
Risk to our call: Persistent service sector inflation caused by labour market tightness could see the Fed hike for longer. Conversely, the tighter lending standards, a debt ceiling crisis/government shutdown and a restart of student debt repayments may create an even deeper downturn that triggers a more aggressive Fed rate cut response.
European Central Bank: Carsten Brzeski
Our call: 25bp hike in May and a final 25bp hike in June. The first rate cut will not be before the second half of 2024.
Rationale: The ECB no longer wants to be the unconditional lender of last resort for financial markets, eurozone governments or the area’s economy. Even though headline inflation will come down further, sufficient pipeline pressure in services and stubbornly high core inflation argue in favour of more rate hikes and a ‘high for longer’ approach. Even if monetary policy tightening further undermines the economic outlook for the eurozone, the ECB will not consider any reversal of the current stance until both projected and actual inflation are clearly moving towards 2% again.
Risk to our call: In a more benign economic environment, the ECB could hike rates further than the currently expected 50bp. On the other hand, a sharper drop in inflation and an abrupt easing of monetary policy in the US could force the ECB to loosen monetary policy in early 2024.
Bank of Japan: Min Joo Kang
Our call: Policy rate hikes are unlikely this year, but adjustments to the Yield Curve Control are possible as early as June. One option would see the BoJ target 5-year government bond yields (JGBs) instead of the current policy, which caps 10-year yields at 0.5%.
Rationale: With strong wage growth and a modest service-led recovery, core inflation is expected to stay above the long-term average in 2023. There will also be growing calls to correct distortions in the bond market. So, the BoJ should eventually adjust or abandon the YCC policy during the year and pave the way for policy rate normalisation in 2024.
Risk to our call: The BoJ is concerned about the economy returning to deflation. The BoJ will carefully examine if the strong wage growth is just a one-off event this year before deciding whether to postpone the policy change to next year.
Bank of England: James Smith
Our call: 25bp rate hike in May, followed by a pause. No rate cut this year.
Rationale: It had looked like the Bank of England was done with its tightening cycle and, in recent comments, various officials have sought to keep options open. But the Bank has said that if fresh signs of “inflation persistence” emerge, it could hike further. Remember, recent wage and CPI data both came in above expectations and suggest another increase should be the base case for May. That said, policymakers have been explicit that much of the impact of past hikes is still to feed through, so we think the bar to further tightening beyond May remains high.
Risk to our call: If services inflation continues to trend higher and recent survey evidence showing reduced price pressures begin to revert, then the Bank could go further – though the three or four rate hikes markets are currently pricing appears extreme.
Source: ING Think