Three major banks met for their policy meetings last week. All of them have de-facto abandoned their tightening biases in favour of a neutral stance, and are ready to adopt an easing bias in coming weeks. But they had to push back against market expectations that they would prematurely cut policy rates. Let’s discuss each of these central banks in the chronological order in which they made their decisions.
On December 13th, the US Federal Reserve announced its decision to keep its policy rates unchanged for the third consecutive time, after the September and November “skips.” More than that, the new Summary of Economic Projections (SEP) showed that FOMC participants expect three 25-bps cuts in 2024, four cuts in 2025 and three more in 2027, which would bring Fed funds rate from 5.25-5.50% to 2.75-3.00% at the end of the forecast period. That is still above the longer-term level of 2.5%, which is considered a sort of short-term neutral rate (whose value is likely to be higher, by now). Having said all this, in determining the need and extent of “any additional policy firming”, the FOMC will continue to monitor incoming data on economic activity and financial conditions. As Chair Powell explained during the press conference, the inclusion of this sentence was necessary to make sure that the possibility of further rate hikes was not completely removed. In spite of this caveat, financial markets celebrated with a fall in market yields, a weaker dollar, and higher equity prices.
The following day, the Monetary Policy Committee of the Bank of England also announced its decision to keep the Bank Rate unchanged at 5.25%, with a 6-3 split in favour of the decision. Three MPC members (J. Haskel, M. Greene and K.L. Mann) voted for a 0.25% increase in the Bank Rate in consideration of the still-elevated level of headline and core inflation (respectively at 4.6% and 5.7%) and a still-resilient labour market, in spite of the weakening economy.
During the press conference, central bank governor Andrew Bailey specifically had to say that it was too early for the MPC to start contemplating possible rate cuts, even if the market is pricing them in starting from May/June 2024. Of the three major central banks, this was the strongest pushback against market expectations of rate cuts, taken in consideration of the still-elevated level of inflation.
Also on Thursday, the European Central Bank announced its unchanged policy stance. With its updated forecasts, it revised its growth and inflation forecasts lower. The ECB, the descendant of the German Bundesbank, also said that rates will have to remain at “sufficiently restrictive levels for a sufficiently long period of time”, to allow inflation to fall to target levels over the forecast horizon. Given the deceleration of Eurozone economy, the ECB could have indicated more clearly that rate cuts are on the horizon, as the Fed did, but instead it decided to send a relatively hawkish signal. Actually, the ECB also decided to taper, from H2 2024, the reinvestment of the principal proceeding of PEPP bonds, which in itself is a tightening move. In spite of this, markets were still digesting the news from the Fed and continued to celebrate the perceived pivot by central banks.
While all three central banks have remained on hold in December, they all reiterated that it is too early to declare victory against inflation. In spite of this, market participants are now looking at incoming easing cycles, which they expect to begin in the first half of 2024. The skirmishes between markets and central banks are set to continue for a few more weeks.
