A bumper week for central banks as Fed, ECB and BoE prepare to release rate decisions

Fed to rein in hopes of rate cuts?

The Federal Reserve is expected to maintain the current Fed funds target range of 5.25-5.5% at the upcoming FOMC meeting. This decision is influenced by recent economic indicators such as softer activity numbers, cooling labour data, and moderate month-on-month inflation figures. These factors suggest that the current monetary policy is likely restrictive enough to bring inflation down to the desired 2% level in the coming months.

However, the focus of attention is likely to be on the individual forecasts of Fed members. The market perceives that significant rate cuts are imminent, but it remains to be seen how far the Fed members will align with this sentiment. It is anticipated that there will be considerable resistance to such expectations.

Markets are now firmly anticipating the possibility of aggressive interest rate cuts by the Fed in 2023. On November 1st, after the Fed kept rates steady, markets saw only a 20% chance of a final rate hike in December and expected around 90 basis points of cuts through 2024. Currently, markets clearly believe interest rates have peaked, with 125 basis points of cuts priced in over the next year.

The risk for this Fed meeting is that the central bank proves to be insufficiently dovish for current investor expectations. Risk assets like stocks having come so far since late October that they are now pricing in a lot more good news. Disappointment in the wake of the Fed meeting could spark a selloff in equities and a surge in the dollar that could undermine hopes of a ‘Santa rally’ in stock markets.

ECB split on the way forward

The European Central Bank (ECB) is facing internal disagreements regarding future monetary policy. Some members are open to further rate hikes, while others believe rate cuts may be necessary. The weak economic backdrop does not justify rate hikes, but the solid labour market and wage growth, along with inflation above target, make discussions on rate cuts premature.

The ECB has mentioned the "last mile" in bringing inflation back to target, emphasizing the need to keep rates higher for longer. Wage settlements will also play a significant role in determining the ECB's stance.

Despite the ECB's gradual shift towards a more dovish stance, there is a risk of underestimating disinflation. The ECB is cautious after years of above-target inflation, and will be slow in moving towards a more dovish stance.

Bank of England to stick to tough stance on inflation

The Bank of England (BoE) is expected to maintain its firm stance against interest rate cuts in the UK, despite other central banks considering a change in their approach to inflation. The BoE is projected to keep borrowing costs at a 15-year high and emphasise the need for elevated rates to combat stubborn inflation in the country.

While the European Central Bank and the US Federal Reserve are also likely to keep their benchmark rates unchanged, officials at both institutions have indicated a potential shift towards rate cuts. Although the UK's inflation rate has decreased from its peak of 11.1% a year ago, it remains above the BoE's 2% target.

The BoE is concerned that despite signs of a cooling labour market, wage growth remains strong following the 14 consecutive interest rate hikes between December 2021 and August this year. Governor Andrew Bailey and other members of the Monetary Policy Committee have consistently emphasized that it is premature to consider rate cuts. However, investors are pricing in a potential BoE rate cut for May or June next year.

Nevertheless, the BoE is perceived to be lagging behind the ECB and the Fed, with markets indicating a 70% chance of rate cuts by March for both institutions.