Interest rates may have peaked – but when will we see rate cuts?

For almost two years now, we have been preoccupied with the question of when interest rates will reach their ‘peak’. Now, with the summit in sight, the focus is shifting to the shape of the mountain that rate-setters are scaling – not just its highest point. 

A more gentle descent from peak interest rates? 

In late August, the Bank of England’s (BoE) chief economist, Huw Pill, said that he would prefer a longer and more steady period of interest rates (a ‘Table Mountain’ shape) over the sharp rise and fall of a ‘Matterhorn’ approach (see chart). In keeping with that, economists expect the BoE, the Federal Reserve and the European Central Bank (ECB) to take a cautious approach to rate cuts in the months ahead. In their September meetings, all three major central banks stressed that they would be prepared to raise rates again in the face of persistent inflationary pressures – the Fed went even further, issuing projections implying the potential for a further hike before the end of the year.

Both markets and economists now expect a long period of elevated interest rates before cuts eventually come next year. Analysts at Investec see the Fed moving first with a June rate cut, before the BoE and ECB follow suit later in the summer. But only a year ago, the stage looked set for a much faster turnaround. Consensus forecasts implied that the UK and eurozone would be ready to ease policy by the end of 2023, while US central bankers were initially expected to embark on rate cuts by the middle of this year. 

Investec economists have noted that “the tone is now turning to how long rates remain at the current restrictive levels rather than the peak itself”. The 10-year Treasury yield has risen to 4.6 per cent –  a 16-year high, and a 0.6 percentage point increase since the Fed’s July policy meeting. Barclays analysts said that “bond markets are finally listening to the Fed's message of higher for longer and we still do not think the sell-off has been excessive”. Descending Table Mountain may be more gentle than clambering down the Matterhorn, but the prospect of a slower pace of rate cuts was enough to rattle markets in September.

A global tipping point

But as we mull over the shape of our mountain ranges, we risk missing a bigger trend. Globally speaking, by the final quarter of the year, it is likely that hiking central banks will no longer be in the majority. China, Brazil, Chile, Hungary and Poland have all already cut interest rates and economists expect Indonesia, Czechia and Colombia to soon follow suit. 

According to Jennifer McKeown, chief global economist at Capital Economics, emerging market economies are well placed to ease policy relatively soon. In some cases, countries have been untroubled by inflation, but have seen economic activity weaken – China is a case in point. Elsewhere, central bankers responded early and aggressively to high inflation, and can now cut rates from very high levels. In September, the Brazilian central bank cut interest rates by 0.5 percentage points to 12.75 per cent, while the National Bank of Poland kicked off its easing cycle with a 0.75 percentage point cut, taking the base rate to 6 per cent. According to forecasts from Capital Economics, by this time next year, 21 of the world’s 30 major central banks will be cutting interest rates. 

We are only starting to feel the impact of higher interest rates 

But Deutsche Bank macro strategist Henry Allen thinks that “it is much too early to sound the all-clear”. After all, monetary policy operates with long time lags, and the full effect of interest rate hikes will not be felt on the economy for months to come. The fact that investors now expect interest rates to stay higher for longer will intensify the squeeze: Allen added that “expectations of tighter policy are also having an impact on the economy”. Although the era of rate hikes may be coming to an end, the impact of higher interest rates is only just beginning to filter through.