Investors are raising interest rates sharply in the coming months after the world’s major central banks strengthened their resolve to tackle rising prices, signaling they would prioritize inflation over growth.
A Financial Times analysis of interest rate derivatives tracking borrowing cost expectations in the US, UK and the eurozone shows that markets are expecting a more drastic movement during the last quarter of 2022 than at the beginning of this year.
The mood swings come ahead of important policy meetings this week by the US Federal Reserve, the Bank of England, the central banks of Norway and Sweden, and the Swiss National Bank. It follows a poor August inflation reading in the US and warnings from monetary policymakers on both sides of the Atlantic that they were becoming increasingly concerned that, without substantial rate hikes, higher inflation would prove difficult to spot.
“Central banks agree on how difficult it will be to get inflation back on target and they are trying to get that message out to the markets,” said Ethan Harris, an economist at Bank of America.
Growing expectations that central banks will raise rates even if their economies fall into recession, the World Bank has expressed concern. The Washington-based organization warned last week that policymakers risk sending the global economy into recession next year.
“Central banks will abandon their economies for recession so that inflation can quickly return to its target,” said Mark Zandi, chief economist at Moody’s Analytics. “They understand that if they don’t, and inflation gets deeper, it will eventually result in a more severe recession.”
Since June, the world’s 20 major central banks have raised interest rates by 860 basis points, according to FT research.
As of Friday, markets were pricing in a 25 percent chance that the US Federal Reserve would raise rates by 100 basis points on Wednesday and expect the Federal Funds target to be above 4 percent by the end of the year — almost a full percentage point. higher than at the beginning of August.
The market expects the European Central Bank’s deposit rate to reach 2 per cent by the end of the year, up from 0.75 per cent now. The latest bet is a percentage point higher than what investors predicted in early August. The ECB’s chief economist Philip Lane told a conference call over the weekend that he expects it to raise rates “several times” this year and early next year. He said this is likely to include lost growth and some “pain” of jobs to cushion demand, reflecting the ECB’s growing concern that inflationary pressures are spreading from energy and food to other products and services. .
Year-end interest rate expectations for the Bank of England are also high, with economists largely split between a 50 basis point and 75 basis point increase in Thursday’s vote.
Switzerland’s central bank is expected to raise its policy rate by 75-100 basis points next Thursday, ending a seven-year experiment with negative interest rates.
Paul Hollingsworth, chief European economist at BNP Paribas, said central banks were “extending their tightening cycles” despite signs of weakening growth.
A major shift in market expectations came after policymakers such as Federal Reserve Chairman Jay Powell and ECB executive board member Isabel Schnabel attended the Kansas City Fed’s annual Jackson Hole conference in late August.
“The sucking voice you hear is the sound of rate hikes expected by policymakers from 2023 to 2022,” said Krishna Guha, vice-chair of investment banking advisory firm Evercore ISI, after the meeting. “We are eliminating globally something that – looking at the whole of 2022 – would be more akin to a scrambled level shift than a traditional tightening cycle.”
Since Jackson Hole, US inflation has proved more stable than expected, coming in at an annual rate of 8.3 percent in August. In the Eurozone, price pressure is expected to reach double digits in the coming months. The UK government’s £150bn energy aid package will reduce inflation in the short term, but increase price pressures in the medium term by boosting demand.
While central bankers such as Schnabel have indicated that, while inflation is poised to remain near record highs for the foreseeable future, they are no longer willing to place their faith in economic models that show a decline in price pressure over the next few years. .
While much of the inflation seen in Europe remains the result of rising energy prices due to the war in Ukraine, there are increasing signs in both the single currency area and the UK that price pressures have become wider and more entrenched.
“Typically, central banks will see these volatile price gains as a temporary measure,” said Jennifer McCain, Head of Global Economics at Capital Economics. “But in an environment where core inflation is already high and inflation expectations and wage negotiations begin to drive higher energy prices, monetary policymakers cannot take that risk.”
Additional reporting by Martin Arnold