Major central banks hold rates steady; markets price in rapid cuts
Summary
The Bank of England (BoE) held rates for a third consecutive meeting at 5.25% with a vote of 6–3. The bank rate remains at the highest level since the financial crisis, amidst the backdrop of inflation more than double the Bank’s target and a stagnating economy. The latest data shows the U.K. economy contracted in October 2023.
The European Central Bank (ECB) followed suit with the U.S. Federal Reserve and BoE, holding rates steady with deposit and refinancing rates unchanged at 4.00% and 4.50%, respectively. The ECB faces a different dilemma than its British counterpart — inflation in the Eurozone is much nearer the 2.00% target with current forecasts anticipating the inflation target will be met in 2025. The emphasis remains on the data, particularly labour market conditions, as the driving factor for the time and speed in which rates will start to come down.
Bank of England
The BoE's Monetary Policy Committee (MPC) voted 6–3 to maintain the bank rate at 5.25%, with three members voting to increase the rate by 0.25 percentage points to 5.50% — with the comment it was “too early to conclude that services price inflation and pay growth were on a firmly downward path."
BoE Governor Andrew Bailey said, "Successive rate increases have helped bring inflation down, but there is still some way to go", and the “persistence of inflation” continues to be an issue. The emphasis remains firmly on the data in driving monetary policy to bring the inflation rate back to target.
Monetary policy will continue to be restrictive for an “extended period of time”. There was no discussion of interest rate cuts, unlike the U.S. Federal Reserve, with Governor Bailey stating it’s “too early to start speculating that we’ll be cutting [rates] soon."
In the MPC’s November Monetary Policy report projections, the modal projection for CPI inflation returns to the 2.00% target by the end of 2025. The three-year SONIA swap rate was down ~13 basis points as markets digested the Central Bank announcements.
Sterling rallied in the wake of the announcements, up 85 basis points to $1.2709, extending the 33-basis-point gains prior to the BoE decision. Global stocks, as well as the FTSE 100, also gained on the back of the dovish pivot from the U.S. Federal Reserve.
European Central Bank
The ECB remains data-driven in determining the future trajectory of interest rates. With some commentaries suggesting the ECB has overtightened, the expectation for an uptick in inflation for the end of 2023, driven by wage growth in Germany, provides a buffer to the ECB when considering its policy in 2024.
Inflation is “likely to pick up again temporarily in the near term”, but will then gradually decline through 2024 before reaching the 2.00% target in 2025. Headline inflation is expected to average 5.40% in 2023, 2.70% in 2024, 2.10% in 2025, and 1.90% in 2026.
In their latest meeting, the ECB maintained their previously stated principle of interest rates being “higher for longer". This was reinforced with rates being at “sufficiently restrictive levels for as long as necessary” despite easing inflation.
Domestic price pressures are still present in the Eurozone economy through the strong growth of labour costs, with the expectation that rising real incomes and foreign demand will drive economic growth in the longer term. President Lagarde outlined that economic growth was tilted to the downside, highlighting the potential risks that tightened monetary policy, a weaker-world economy, and geopolitical issues could weigh-in on Euro area growth.
The three-year, three-month EURIBOR swap rate fell by ~13 basis points to 2.549%, following the dovish pivot by the U.S. Federal Reserve and announcement by the ECB.
Moving forward
Markets are pricing in interest rate cuts to be made by the BoE in 2024 amidst the looming risk of a recession in the U.K., with high-borrowing costs for individuals and businesses impacting both consumption and investment in the economy. Interest rate cuts are priced in as early as May 2024 with up to four cuts throughout the year, representing over 100-basis-points worth of easing, despite the commentary from the BoE indicating that rates would be higher for an extended period.
The ECB also pushed back against expectations of rapid interest rate cuts. However, market expectations have the ECB as one of the first major central banks to start cutting rates, with 140-basis-points worth of cuts priced in for 2024.
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