20 December 2022
While many eyes across the globe were focused in anticipation of the Argentina and France World Cup final last week, conversations were being had by the three main Western central banks, in which all decided to raise interest rates by 0.5% within 24 hours of each other.
However, there was a noticeable difference in the messaging that accompanied these actions.
On home soil
Governor of the Bank of England (BoE), Andrew Bailey, was more optimistic. He said:
“We think we’ve seen possibly this week the first glimmer, with the figures released this week, that it’s not only beginning to come down, but it is a little bit below where we thought it would be and that is obviously very good news.”
Bailey shared this after UK inflation dropped from its multi-decade high to 10.7%. Any indications that inflation may finally be declining after dominating much of the economic discourse for a year will be very much welcomed. However, inflation still sits well above the BoE’s 2% target, and even Bailey said there is a chance it may not decline as he had hoped, due to a tight labour market.
The BoE’s decision to increase interest rates to 3.5% on Thursday was influenced by these risks.
Mark Dowding, Chief Investment Officer at Bluebay, said that the BoE has traditionally used rather gentle language in its messaging. He said the bank is “acutely aware of the mortgage rate pass through on households already reeling from higher energy costs”. Adding to that:
“Our 2023 outlook continues to foresee the BoE under delivering versus market expectations, struggling to raise rates above 4%.”
Dowding suggests that this more accommodating stance might contribute to the prolonging of the UK’s inflation problems.
In the eurozone
The European Central Bank likewise increased interest rates last week by 0.5%, but the tone of the announcement was less upbeat about the future. Following the news, ECB President Christine Lagarde stated that she anticipates interest rates will continue rising sharply in light of a substantial upward revision to the inflation outlook.
Azad Zangana, Senior European Economist and Strategist at Schroders, said:
“Money markets had priced the peak in the main ECB interest rate to reach between 2.75% and 3% early next year. However, the signal from the ECB seems to suggest that the terminal rate [highest point] may now need to be higher given the worsening outlook for inflation.”
Across the pond
The US fell somewhere in the middle of these positions with the Federal Reserve increasing interest rates by 0.5%.
Since June, US inflation has been gradually declining, but Fed Chairman Jerome Powell remarked that “we still have some ways to go” in order to get inflation to a more manageable 2%. Dashing hopes that interest rates would start to be cut in the near future, he added:
“I wouldn’t see us considering rate cuts until the Committee is confident that inflation is moving down to 2% in a sustained way.”
This message was sufficient to send markets into a retreat, with the S&P 500 and tech-heavy NASDAQ both declining by over 2%.
Wesley Johnston, Senior Portfolio Manager and Research Analyst at Sands Capital, noted:
“When we talk to companies, we hear that they feel much better about their labour situation today than they have at any point in the past 18 months. The supply chain has also improved a lot.”
He continues by saying that many company valuations have already accounted for a large portion of the effects of inflation. Investors will be hoping that this results in a brighter new year after a challenging 2022 comes to a close and 2023 gets under way.