Central banks around the world have now given the markets a clear message — tighter policy is here to stay

A trader on the floor of the New York Stock Exchange (NYSE) shows the Fed’s rate announcement on November 2, 2022.

Brendan McDermid | Reuters

The US Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank all raised interest rates by 50 basis points this week, in line with expectations, but markets are bracing for their changing tone.

Markets reacted negatively after the Fed raised its benchmark rate by 50 basis points to a 15-year high on Wednesday. That’s a slowdown from the previous four meetings, when the central bank raised 75 basis points.

However, Fed Chairman Jerome Powell said despite recent indications that inflation has peaked, the battle to return it to manageable levels is far from over.

“There is an expectation that services inflation is not going to come down that fast, so we have to keep it that way,” Powell said at a press conference on Wednesday.

“We may have to raise rates to get where we want to go.”

On Thursday, the European Central Bank opted for another modest hike, but suggested a “significant” increase in rates would be needed to curb inflation.

The Bank of England also implemented a half-point hike, adding that it would “respond strongly” if inflationary pressures start to become more sustainable.

The market's reaction to the ECB's Fed announcement is likely to be bearish, the strategist said

George Saravelos, head of FX research at Deutsche Bank, said major central banks had sent a “clear message” to markets that “financial conditions must remain tight”.

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“We wrote at the beginning of 2022 that the year was about one thing: rising real rates. Now that central banks have achieved that, the theme for 2023 is different: preventing the market from doing the opposite,” Saravelos said.

“Purchasing risky assets in a weak inflation environment is a contradiction in terms: the easing of financial conditions it would bring undermines the argument for weakening inflation.”

In this context, according to Saravelos, the ECB and Fed’s apparent shift in focus from the consumer price index (CPI) to the labor market is notable, as it means supply-side movements in goods are not enough to declare “mission accomplished.” “

“The overall message for 2023 seems clear: central banks will pull back on high-risk assets until the labor market starts to turn around,” concluded Saravelos.

Economic views change

The announcements from the Fed and the ECB surprised the market a bit, but the policy decisions themselves were in line with expectations.

Berenberg on Friday adjusted its terminal rate forecasts in line with developments over the past 48 hours, adding an additional 25 basis points for the Fed to raise rates in 2023, bringing the peak to a range between 5% and 5.25%. the first three meetings of the year.

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“We still think inflation will fall to c3% and unemployment will rise well above 4.5% by the end of 2023, which will eventually lead to a less restrictive stance, but for now the Fed is aiming to be higher,” Berenberg chief economist Holger Schmieding said.

Eurozone inflation has peaked, says Barclays

The bank also raised its forecasts for the ECB, which will now raise rates at a steady pace to a “limiting level” for several upcoming meetings. Berenberg added another 50 basis points on March 16 to its expectation of 50 basis points on February 2. This brings the ECB’s main refinancing rate to 3.5%.

“However, once inflation falls to 2% in 2024, from such a high level, the ECB will have to cut rates again,” Schmieding said.

“We are now looking for two cuts of 25 bps each in mid-2024, leaving the ECB’s key refinancing rate unchanged at 3.0% until the end of 2024.”

The Bank of England has been slightly more dovish than the Fed and the ECB, and future decisions will depend on how the UK’s expected recession plays out. However, the Monetary Policy Committee has repeatedly cautioned against the tightening of the labor market.

Berenberg expects an additional 25 basis point hike in February, taking the bank rate to a peak of 3.75%, 50 basis points in the second half of 2023 and another 25 basis points by the end of 2024.

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“But against the backdrop of positive surprises in recent economic data, an additional 25bp rate hike by the Fed and BoE will not materially change our economic outlook,” explained Schmieding.

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“We still expect the US economy to contract by 0.1% in 2023, followed by 1.2% growth in 2024, while the UK is expected to enter recession with GDP contracting by 1.1% in 2023, followed by 2024 will rise by 1.8% in .

However, for the ECB, Berenberg sees an additional 50 basis points expected from the ECB in late 2023 and early 2024 to have a noticeable impact, halting growth.

“While we will keep real GDP unchanged for next year, we will reduce the rate of economic recovery from 2.0% to 1.8% in 2024,” Schmieding said.

As he noted, the forward orientation and tone change of central banks during 2022 could not be a reliable guide for future political actions.

“We view the risks to our new forecasts for the Fed and BoE as balanced on both sides, but with the euro area’s winter recession likely to be deeper than the ECB projects and inflation falling significantly from March onwards, we expect the ECB’s final rate hike in March 2023 to be less than 50 bps. , we see a good chance that it will be 25 bits,” he said.

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