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Our views 15 December 2023

Three central banks, lots of market reaction

5 min read

This was always going to be an eventful week with three major central banks. The Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) announcing policy decisions over a 24-hour period.

Although, as expected, all these central banks kept rates on hold, market reactions have been strong (particularly to the Fed) with investors quick to price in even more rate cuts for central banks next year.

However, without significant recessions, in my view, central banks will be more cautious than otherwise, ‘feeling their way’ lower with rates as they become more confident that inflation is returning sustainably to target. It will be interesting to see if we get any central bank speakers piping up over the next two or three weeks, pushing back more firmly against market pricing especially in the US.

My current forecasts for interest rates in these three economies have not been assuming any rate cuts until the second half of the year and then only assumed 50 basis points (bps) of cuts for the US and UK with 75bp from the ECB. Much will depend on how the inflation data evolves, but at this stage, risks are skewed towards more cuts and starting earlier, especially in the US where we are expecting at least 75bp of cuts now seems a more reasonable central case and with both the Fed and ECB cutting rates first in Q2 2024.

Presumably the Fed were not intending the market to price in 150bp of rate cuts for 2024 though…

It is understandable for Fed participants to feel more confident than they were about inflation sustainably returning to the 2% target given progress so far, but I doubt they intended to project enough confidence to justify 150 bp of cuts as was priced into markets in the aftermath of the meeting this week. Financial conditions are a key channel by which monetary policy is transmitted and too much easing in financial conditions too soon could prove problematic where inflation and pay growth still look a bit too strong for comfort.

In the US, Federal Open Market Committee (FOMC) participant forecasts (the so-called ‘dot plots’) now imply 75bp of cuts in 2024 with a further 100bp cuts pencilled in for 2025, likely anticipating a 25bp a quarter pace. The range of forecasts from US central bankers is very wide though and eight out of nineteen participants don’t have them cutting rates as far as 75bps in 2024. Although Fed Chair Powell was at pains to say they do not want to take a further hike off the table and for now were still grappling with the question of whether they’d done enough, pushback against market pricing could have been stronger. He did not indicate that looser financial conditions were a problem or that they were uncomfortable with market pricing and noted that they were “very focused” on the risk of keeping rates too high for too long.

In contrast, the effective pushback from the BoE and ECB was stronger

The pushback was arguably easier for the BoE where – unlike the Fed – they don’t publish individual MPC (Monetary Policy Committee) forecasts and did not (as is usual in December) hold a press conference (but unlike the Fed and ECB). Going on the minutes alone, there wasn’t much encouragement of rate cuts.

For the BoE, still a “finely balanced” hold or hike decision

Although it sounded like one MPC member might be close to voting for a cut, no less than three out of nine MPC members voted again to hike rates and, more broadly, they again flagged that the decision to hold or hike was “finely balanced”. Based on their November economic projections “the Committee continues to judge that monetary policy is likely to need to be restrictive for an extended period of time.” [Author's italics]

They continue to judge that risks to their inflation forecasts are on the upside. There were definite dovish elements to some of their economic commentary, including noting that “The latest intelligence from the Bank’s Agents suggested that demand had weakened slightly further over recent weeks.” However, they did play down the fall in services inflation seen in October and see upside risks to the outlook for pay growth (pay growth and services inflation remain key focus points for the MPC). For the majority of MPC members who voted for rates to be on hold it was simply “Too early to conclude that services price inflation and pay growth were on a firmly downward path”.

So, overall, there wasn’t much change in tone from the BoE, but the February Report will be accompanied by their annual “stocktake” of supply capacity (and, as usual, will be accompanied by a press conference) so would probably be the more likely time to expect a bit of a shift in tone.

ECB’s Lagarde pushes back

Although the ECB guided towards an earlier end to pandemic emergency purchase programme (PEPP) reinvestments (i.e. towards quantitative tightening), President Lagarde was at pains to point out that decisions on PEPP were separate from those on interest rates.

Going into the meeting, various ECB speakers had already broached the topic of rate cuts, effectively opening the door for cuts in H2 2024 while pushing back on the chance of a near-term cut. The question was how far Lagarde would push back against the degree of easing now priced into markets for 2024. Despite being in “covid recovery mode” with acute bronchitis, Lagarde clearly articulated a number of points that summed up to a reasonable amount of pushback against market pricing. Those included that:

  • They still regard domestic price pressures as “elevated”. On inflation they want more evidence on domestic inflation pressures in particular, saying that H1 will be data rich.
  • Lagarde mentioned a couple of times in answers to questions (and there were a lot of questions on rate cuts) that staff forecasts, including their new lower inflation forecasts, incorporated market pricing up to the cut-off date of 23rd November. Looking at market pricing at that point, there was just over one 25bp rate cut priced into the middle of 2024 (more than 60bp as of Wednesday).
  • They did not discuss rate cuts at all: according to Lagarde, there was “No discussion and no debate” on that; “We did not discuss rate cuts at all”; “This was just not discussed.” Following on from the points above, she said that “Between hike and cut there is a whole plateau – a whole beach – of hold.”

Altogether, comments from Lagarde were arguably consistent with rate cuts in H2 but did push back against anything happening nearer term. In that sense her comments were broadly in line with other recent ECB commentators. But, as she said, they are data dependent; you could argue that data might come in consistent with a rate cut as early as Q1 …it just doesn’t sound like the ECB are anywhere close to that point yet.


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