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

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 progressing in shifting tunes.

Markets reacted negatively after the Federal Reserve on Wednesday raised its benchmark interest rate by 50 basis points to its highest level in 15 years. This was a slowdown from the previous four meetings, where the central bank implemented a 75 basis point increase.

However, Federal Reserve Chairman Jerome Powell noted that despite recent indications that inflation may have peaked, the fight to bring it back to manageable levels is far from over.

“There’s a real expectation that service inflation won’t come down very quickly, so we’ll have to stay there,” Powell said at a press conference on Wednesday.

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

On Thursday, the European Central Bank followed suit, also opting for a smaller hike but indicating it would need to raise interest rates “significantly” to tame inflation.

The Bank of England also increased by half a point, adding that it would “respond aggressively” if inflationary pressures start to look more firm.

Major central banks have given markets a “clear message” that “financial conditions must remain tight,” said George Saravelos, head of foreign exchange research at Deutsche Bank.

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

“Buying risky assets on the hypothesis of weak inflation is a contradiction in terms: the easing of financial conditions that it entails undercuts the case for soft inflation.”

In this context, Saravelos said, the ECB’s and Federal Reserve’s apparent shift in focus from the Consumer Price Index (CPI) to the labor market is notable, as it suggests that supply-side movements in commodities are not enough to declare “mission accomplished.” “

“The overall message for 2023 seems clear: central banks will push riskier assets until the job market starts to turn around,” Saravelos concluded.

Revisions to economic forecasts

The hawkish messages from the Federal Reserve and the European Central Bank somewhat surprised the market, although the policy decisions themselves were in line with expectations.

Berenberg on Friday revised its final rate forecast according to developments in the last 48 hours, adding an additional 25 basis points rate hike for the Fed in 2023, bringing the peak to a range of 5% to 5.25% over the period. . The first three meetings of the year.

“We still believe that a drop in inflation to C3% and a rise in the unemployment rate above 4.5% by the end of 2023 will eventually lead to a shift to a less restrictive stance, but for the time being, the Fed clearly intends to rise,” the chief economist said. In Berenberg Holger Schmieding.

The bank also raised its forecast for the European Central Bank, which now sees interest rates raised to “restrictive levels” at a steady pace for more than one upcoming meeting. Berenberg added an additional 50 basis points move on March 16 to its current forecast of 50 basis points on February 2. This brings the main ECB refinancing rate to 3.5%.

“From this high, it is likely that the ECB will need to cut interest rates again once inflation drops to close to 2% in 2024,” Schmieding said.

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

The Bank of England has been more dovish than the Federal Reserve and the European Central Bank, and future decisions are likely to depend heavily on how the expected UK recession develops. However, the MPC has repeatedly warned to be cautious about tightening the labor market.

Berenberg expects a further increase of 25 basis points in February to raise the bank rate to a peak of 3.75%, with cuts of 50 basis points in the second half of 2023 and another 25 basis points by the end of 2024.

“However, against the backdrop of positive surprises in recent economic data, an additional 25 basis points increase in interest rates from the Fed and the Bank of England does not make a material difference to our economic outlook,” Schmieding explained.

“We still expect the US economy to contract by 0.1% in 2023 followed by growth of 1.2% in 2024, while the UK is likely to suffer a recession with a 1.1% drop in GDP in 2023, followed by a recovery of 1.8%. in 2024.”

For the ECB, though, Berenberg sees an additional 50 basis points expected to have a clear impact, clearly limiting growth in late 2023 and early 2024.

“While we leave next year’s real GDP demand unchanged at -0.3%, we lower our call for the pace of economic recovery in 2024 from 2.0% to 1.8%,” Schmieding said.

However, he noted that over the course of 2022, central banks’ forward guidance and shifts in tone did not prove to be a reliable guide for future policy actions.

“We see the risks to our new Fed and BoE forecasts balanced in both directions, but given that the winter recession in the eurozone is likely to be deeper than the ECB’s projects, and as inflation is likely to decline significantly from March onwards, We see a good chance that the ECB’s final rate hike in March 2023 will be 25 basis points instead of 50 basis points.”