- Inflation is moving in the right direction
- Have rate-setters already done enough?
With inflation on a convincingly downward path, have central bankers finally done enough? If comments from rate-setters over the summer are anything to go by, this month's policy meetings should mark the beginning of the end of this extraordinary period of interest rate hikes.
But as we reach the end of the hiking cycle, it could be hard to see the wood from the trees. Does a decision to leave rates unchanged represent a policy ‘skip’, a ‘pause’, or the true end of interest rate hikes? We are also facing a period of policy divergence, as the European Central Bank pressed ahead as the Federal Reserve stood pat. We look at what this month’s central bank decisions really mean.
Federal Reserve: Wednesday 20 September
Key policy rate: unchanged at 5.25-5.50 per cent
The Fed voted to keep interest rates unchanged at 5.25-5.50 per cent on Wednesday, but signalled support for a further rate hike later in the year. The move, dubbed a "hawkish hold" by analysts at Dutch bank ING, was in line with market expectations.
The Fed’s latest projections suggest this decision represented a ‘pause’, rather than a definitive end to the hiking cycle. ‘Dot plots’ released on Wednesday indicated the prospect of a further hike before the end of the year, taking the Federal Funds Rate to a peak of 5.50-5.75 per cent.
Traders were less convinced, and according to the CME FedWatch tool, investors currently see only a 30 per cent chance of a further hike at the November meeting. Analysts at ING said that “given the challenges the economy faces, the market is understandably sceptical” about the more hawkish messaging.
In a statement released after the decision, policymakers said that “the Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals”.
Despite an uptick in the rate of inflation this month, rate-setters remained confident that US data was moving in the right direction. Headline inflation accelerated from 3.2 per cent to 3.7 per cent, but encouragingly, there was little sign of this feeding into core inflation figures, which fell from 4.7 per cent to 4.3 per cent.
As a result, rate-setters revised their forecasts for core PCE inflation for the end of the year. Policymakers also made more optimistic forecasts for economic growth and unemployment, suggesting that the US economy will achieve a ‘soft landing’ in 2024.
Crucially, the Fed signalled that it expects interest rates to remain higher for longer next year. The latest projections implied that interest rates would fall to an average of around 5.1 per cent next year, far higher than the 4.6 per cent implied in the June meeting.
Bank of England: Thursday 21 September
Key policy rate: 5.25 per cent
Thursday’s BoE interest rate decision hangs in the balance after the latest inflation figures showed an unexpected dip in the annual rate of inflation.
Economists had widely anticipated a temporary uptick in the rate of CPI this month due to base effects and higher fuel prices. Instead, the headline rate of inflation decelerated from 6.8 per cent in July to 6.7 per cent in August. Encouragingly, the core inflation rate dropped from 6.9 per cent to 6.2 per cent, while services inflation also fell significantly from 7.4 per cent to 6.8 per cent.
In August, BoE rate-setters said that they would raise interest rates for a fifteenth time if they saw evidence of “persistent pressures”, meaning that Thursday’s decision now looks uncertain.
Despite positive inflation news, recent data releases have been decidedly mixed. GDP shrank by 0.5 per cent in July, leading to fears that the Bank could ‘overtighten’ if it implements further interest rate hikes. Yet wage growth remains high, with average earnings outpacing inflation again.
Following the inflation release, Tomasz Wieladek, chief European economist at T. Rowe Price said that “although near-term inflation dynamics are looking better, and the weakness in demand demonstrates the monetary policy transmission mechanism is working, the medium-term inflation outlook likely worsened since August due to higher pay growth surprises”.
After Wednesday’s inflation release, market pricing implied that there was only a 50 per cent chance of a further final 0.25 point hike, when it was seen as a virtual certainty earlier in the week.
Yet many analysts continue to expect a final rate increase from the BoE on Thursday. Following the inflation data, Charles White Thomson, CEO at Saxo UK, said the UK remained an "inflationary outlier" and pressure remained on the Bank of England to "suppress and manage inflation". He added: "We [still] expect a 0.25 point rate hike to 5.5 per cent tomorrow.”
