This week started quietly, but the past 48 hours have seen most of the major central banks meeting with no subsequent policy moves
However, there was plenty of guidance given for the future path of rates and the prospect of them staying higher for longer.
The Bank of England’s meeting yielded the most surprising outcome. While on the day the decision was seen as finely balanced, as proved by the split vote of five to four to keep rates on hold, a rate hike seemed all but guaranteed going back just a week or so ago.
However, the UK inflation numbers published on Wednesday clearly tipped the balance in favour of the BoE holding rates at 5.25%, bringing to an end a run of 14 consecutive hikes stretching back to December 2021. The Bank signalled this was only a pause, however, and that it would respond if inflation does not fall as expected. Governor Andrew Bailey said “inflation has fallen a lot in recent months, and we think it will continue to do so … but there is no room for complacency. We need to be sure inflation returns to normal and we will continue to take the decisions necessary to do just that”. The Bank implied that rates would remain elevated with the MPC saying rates would be “sufficiently restrictive for sufficiently long”.
The market reaction saw sterling weaken with the belief that the Bank is done with rate hikes as economic data weakens and inflation rolls over. Market pricing still implies a further 25 basis point hike by next spring, but if inflation continues its downward trend this may well prove incorrect. The Bank will also be mindful that the full impact of the 14 previous rate hikes has yet to fully feed into the economic data and it will need to balance the fight against inflation against a weakening economic backdrop.
Across the pond, the US Federal Reserve also kept rates on hold, an outcome that was widely anticipated. However, the messaging from the Fed was interpreted as hawkish, with the “dot plot” of rate expectations implying one further rate hike in 2023 and only two rate cuts in all of 2024. Chair Jay Powell reinforced a “higher for longer” outlook saying the Fed was now able to “proceed carefully” and while the last few inflation readings have been “very good”, they were not yet enough for the Fed to be confident they had reached a “sufficiently restrictive” stance.
Powell suggested the “neutral rate” may have shifted higher; the dot plot shows rates are expected to still be close to 3% by the end of 2026. Powell downplayed the prospect for cuts, saying the Fed was “never intending to send a signal” about the timing of this with “so much uncertainty around this”.
The Bank of Japan also met, and as expected rates were kept on hold at -0.1%. Governor Ueda said its inflation goal was not yet in sight (CPI for August was 3.2% but the Bank sees this as the “wrong kind” of inflation) and noted the need to keep policy loose given the “extremely high uncertainty” around wages. The BoJ will be patient in ensuring that a base level of inflation persist in the economy before raising rates, conscious of the years of deflation the economy has endured.
The economic numbers this week have been headlined by the UK inflation data for August. The pace of price increases eased, defying expectations of a rise driven by higher fuel prices as the near 20% hike in the oil price seen between June and the start of August fed through into petrol and diesel prices. CPI in August was 6.7% year-on-year, down from 6.8% in July and below consensus expectations of 7%. Core inflation, which excludes food and energy prices, was 6.2%, down from 6.9% in July, while CPI was the lowest since February 2022. In digesting the data, markets lowered expectations for the BoE to hike rates, a move that proved prescient given the outcome of the MPC’s meeting yesterday.
In the US, housing market data suggested the sector was cooling once again, having stabilised in the first half of the year. The survey of housebuilders was weaker than expected, falling to a five-month low. This figure weakened every month last year, before climbing for the first seven months of this year. Data on new housing starts was significantly weaker than expected, falling to the lowest level since the pandemic impacted May 2020’s data.
Housing does appear to be a sector in which interest rate hikes are having a significant impact. While many US consumers are tied to 30-year mortgages and will therefore not yet have felt the impact of higher rates, anyone taking out a new mortgage or moving house is facing a rate of over 7.5%, up from 3.05% two years ago. This is having a significant impact on transactions, with existing home sales in August falling to a seven-month low. Much like the UK, a lack of inventory is helping keep a floor under house prices.
The OECD published its updated world economic outlook this week, and said it expects the global economy to slow as interest rate hikes weigh on activity and China’s rebound from the Covid pandemic disappoints. The OECD sees “sub-par” global growth in 2023, falling to 2.7% next year. Aside from the pandemic hit 2020, these levels are the weakest since the Global Financial Crisis. The OECD warned that risks to its forecast were to the downside, with the potential for rate hikes to have a stronger impact than expected, though inflation may prove persistent, requiring further monetary tightening. It suggested central banks should not ease back on tightening, with core inflation remaining stubbornly high in several economies, with “limited scope for rate cuts well into 2024” and monetary policy needing to stay restrictive “until there are clear signs that underlying inflation pressures have durably abated”.
It looks more and more like we are at, or very close to, the end of interest rate hiking cycles in the US, UK and eurozone. Central banks across all three economies have raised rates aggressively and are seeing their policy moves bear fruit in terms of inflation rolling over. But we are yet to fully see the impact of this rate hiking cycle as the lagged effect of 12-18 months of rate hikes is yet to feed through to the economy. While investors can take comfort from what may well be a peak in rates, there is still a need to get comfortable with a “higher for longer” environment where rates stay elevated for an extended period to ensure inflation is truly defeated. An economic “soft landing” could well extend this period, and while a “hard landing” may well mean rate cuts, it also implies wider economic and earnings pain. Investors need to be careful what they wish for…
Kind regards,
Anthony.
