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Market Update

ECB hikes 25 bps while BoE keeps rates steady

September 21, 2023


The Bank of England (BoE) announced it would keep rates on hold at today's meeting, following 14 consecutive rate hikes that have taken borrowing costs to 5.25%, the highest level since 2007. A 25-basis-point rate hike was expected at the start of the week, but the release of August inflation data showing price growth unexpectedly slowed — sharply for core prices — left the market split on the Bank's decision.

The European Central Bank (ECB) raised interest rates to a record high last week, as hawks narrowly won the argument that prolonged inflation risks were greater than rising recession risks. Upward revisions to ECB staff inflation projections were leaked prior to the meeting, preparing markets for a potential hike priced with only a 25.00% probability. However, the accompanying statement strongly suggests that this is the last rate hike in the current cycle, stating rates have reached a level that will make a substantial contribution to bringing inflation back to target.

Bank of England

The BoE's decision to keep rates on hold was clearly a close one, with this week’s inflation data providing optimism from a majority of the MPC that price pressures can be contained with borrowing costs at current levels. The five members who voted to keep rates unchanged also cited the loosening labour market and falling business sentiment as reasons for their decision.

The August CPI data was welcome news for the central bank and U.K. households that have contended with the highest rates of inflation across the G10 economies. Core CPI now sits at 6.20%, down from 6.90%, and the monthly increase of just 0.10% is very encouraging. Equally, there was evidence of disinflation across a range of categories, particularly for goods and vehicles, while food inflation is also coming down quickly.

However, the latest wage growth data — showing pay increasing at a joint record pace of 7.80% in July — is undoubtedly causing concern among the remaining four members that increased costs for businesses will keep price pressures elevated.

The BoE’s statement kept the door open for another rate hike, noting that further tightening would be needed if evidence of more persistent inflationary pressures were to emerge. For now, the market is also pricing the possibility of another hike by the first quarter of next year, but with unemployment rising and economic activity weakening, further tightening carries significant risk of recession.

European Central Bank

Ahead of last Thursday’s ECB meeting, the Bank’s decision was seen as a coin toss between raising rates or keeping them steady. President Christine Lagarde said during the press conference that some members “wanted more patience.”

But with annual consumer prices rising 5.30% in August, the same pace as the previous month and upward revisions in the central bank’s new forecasts, showing that inflation would be slightly higher this year because of higher energy prices, the central bank opted to “reinforce progress towards the target.”

The accompanying statement hinted that further rate hikes were less likely, stating “interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”

The bar to raising rates again has been set higher, with the ECB acknowledging the recent deterioration in the economy, as the Bank’s policy tightening works its way through the financial system. Demand for loans from businesses and households has weakened, and banks are tightening their lending standards. The Bank cut its growth forecast for this year from 0.90% to 0.70% and for next year from 1.50% to 1.00%, with President Lagarde commenting, “We are going through a phase of very sluggish growth.”

Moving forward

The Bank’s Monetary Policy Committee (MPC) was split on whether to hike, with five members including Governor Andrew Bailey voting to keep rates on hold and the remaining four voting to hike. In a message that is becoming increasingly common among central banks, the BoE is determined to keep rates at restrictive levels as long as needed to bring inflation back to target.

As far as markets are concerned, the ECB’s next move will be to cut rates. However, given how sticky and persistent inflation has proven, Lagarde emphasized that policymakers haven’t even begun to discuss this. So while rates may have peaked, cheaper borrowing costs may still be some way off.

Economic and market update

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