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

A screen shows a Fed rate announcement as a trader works on the floor of the New York Stock Exchange (NYSE), Nov. 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, as expected, but markets are respecting their changing heads.

Markets reacted negatively after the Fed on Wednesday raised its benchmark rate by 50 basis points to the highest level in 15 years. It marked a slowdown from the previous four meetings, in which the central bank implemented a 75 basis point hike.

However, Fed Chairman Jerome Powell indicated that despite recent signs that inflation may have picked up, the struggle to wrestle it down to manageable levels is far from over.

“There’s a real expectation that services inflation isn’t going to come down that quickly, so we’re going to stick with it,” Powell said at a press conference on Wednesday.

“We have to raise prices to get to where we want to be.”

On Thursday, the European Central Bank followed suit, also opting for a smaller hike but suggesting it would need “significant” rate hikes to control inflation.

The Bank of England also implemented a half-point rate hike, adding that it would “respond forcefully” if inflationary pressures continued.

The ECB could be unhappy with the market's reaction to the Fed's announcement, strategists say

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

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

“There is a paradox in the context of buying risky assets on the basis of weak inflation: the easing of financial conditions undermines the rationale for weakening inflation.”

In this context, Saravelos said, the ECB and Fed’s clear shift in focus from the consumer price index (CPI) to the labor market is significant, as it means that supply-side movements in goods are ” “Mission Accomplished” is not enough to declare. “

“The overall message for 2023 seems clear: central banks will continue to stress high-risk assets until the labor market turns around,” Saravelos concluded.

Changes in the economic outlook

The hokey messaging from the Fed and ECB surprised the market somewhat, even though 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 to the Fed’s rate hike in 2023, to a range between 5% and 5.25% during 2023. . The first three meetings of the year.

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“We still think that inflation falling to 3% at the end of 2023 and unemployment rising above 4.5% at the end of 2023 will eventually pivot to a less restrictive stance, but for now, the Fed is clearly Dol intends to rise,” said Berenberg chief economist Holger Schmieding.

Inflation has risen in the Eurozone, Barclays says

The bank also raised its forecasts for the ECB, which it now sees raising rates to “limited levels” at a steady pace for future meetings. Berenberg added another 50 basis point move on March 16 to the current estimate of 50 basis points on February 2. This brings the ECB’s main refinancing rate to 3.5%.

“From such a high level, however, the ECB will likely cut rates again once inflation approaches 2% in 2024,” Schmiding said.

“We are now looking at two increments of 25bp each in mid-2024, leaving our call for the ECB’s main refi rate unchanged at 3.0% at the end of 2024.”

The Bank of England has been slightly more dovish than the Fed and ECB and future decisions will largely depend on how the UK’s expected deficit unfolds. However, the Monetary Policy Committee has repeatedly expressed caution about the tightening of the labor market.

Berenberg expects an additional 25 basis point hike in February to take the bank rate to 3.75%, with a 50 basis point cut 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 from the Fed and BoE does not make a material difference to our economic outlook,” Schmiding explained.

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“We still expect the US economy to contract by 0.1% in 2023 and grow by 1.2% in 2024, while the UK will enter recession with a 1.1% decline in GDP in 2023. and will grow again by 1.8% in 2024.”

For the ECB, however, Berenberg sees the additional 50 basis points expected from the ECB to have a significant impact, curbing growth in late 2023 and early 2024.

“While we leave our core GDP year-on-year unchanged at -0.3% for next year, we reduce the pace of economic recovery to 1.8% from 2.0% in 2024.” Schmiding said.

He noted, however, that during 2022, central banks’ forward guidance and changes in tone have not proven to be a reliable guide for future policy action.

“We view the risks to our new forecasts for the Fed and the BoE as balanced both ways, but as the winter crisis in the Eurozone will likely be deeper than the ECB projects, and as inflation will pick up after March “We see a good chance that the final ECB rate will increase by 25bp compared to 50bp in March 2023,” he said.

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