The World Economic Forum’s latest Chief Economists Outlook highlighted the uncertain backdrop to the US Federal Reserve and European Central Bank’s meetings this week. While 45 per cent of economists thought a global recession was likely this year, the same proportion considered it unlikely. A lack of clarity on the trajectory of the US and eurozone economies prevails.
The Fed is trying to evaluate the impact of instability in regional US banks; the ECB is attempting to assess just how much bite its prior rate rises are having. Both plumped for caution. The Fed raised rates by another 25 basis points, while signalling a potential pause for consideration. The ECB increased rates by a quarter-point too — a smaller rise than previously — while it awaits further data. Though inflation is yet to be beaten, in turbulent times these were sensible decisions.
Markets were expecting the Fed’s rate rising cycle to peak at just above 5 per cent, as it had signalled. Underlying inflation in America — excluding energy and food — remains high at around 5.6 per cent. But weighed against ructions in the banking sector, tighter lending conditions and nascent signs of cooling in the US jobs market, raising interest rates to a target range of 5 per cent to 5.25 per cent while outlining a wait-and-see approach on subsequent decisions made sense. Indeed, the Fed’s statement raised the bar for further “policy firming”, without ruling it out.
With inflation still high, the Fed was right to keep the door open. But traders were looking for clues over when it will begin cutting rates. Chair Jay Powell reiterated the Fed’s bias towards keeping rates elevated for longer, yet markets are still pricing in cuts this year. He might have preferred investors to interpret his post-meeting comments as more hawkish. If high inflation persists, a hefty revision of market rate expectations may be in store.
While the end of rate rises is easier to envisage in the US, it is not quite in view for the eurozone. Inflation nudged back up to 7 per cent last month and the labour market remains red hot. Further rate rises are necessary. There was a debate on whether this week’s 25bps increase to 3.25 per cent should have been 50bps as at its previous meeting, but recent data suggests a slowdown in the pace of rate rises was wise. ECB surveys show slowing bank lending and weaker credit demand. With evidence that prior rate rises are having an impact, a chunkier increase would have been bold. Instead, President Christine Lagarde pulled off a hawkish slowdown: the ECB still has “more ground to cover”, but it is important to assess how quickly it needs to get there.
Central banks’ historic rate-raising cycle may be close to or at its peak, but it is right for central bankers to keep their options open. Investors expect the Bank of England also to raise rates by 25bps next week. With inflation still in double digits, it may also leave the prospect of further rises on the table. High inflation should not be allowed to become entrenched, but with the cost of credit rising sharply over the past year it is fair for central bankers now to fine-tune their rate path as more data comes in.
Some may argue that with inflation still above target, monetary policymakers cannot afford to wait around. But with global inflationary forces easing off, the overall trajectory of inflation is downwards. Higher rates are beginning to tighten lending in the US and Europe, which central banks hope will feed into lower wage growth. Concerns persist, moreover, around the US debt ceiling, banking turmoil and vulnerabilities in the non-bank sector. With the economic fog thickening and a lot of the heavy lifting already done by central banks, now is the right time to start taking stock.