Friday, June 9, 2023

Are central banks going too far with rate hikes?

Central banks have gone to a new level this week in their crusade against inflation. The year ends without any message of a hike in interest rates. 2023 will also be an exercise in making the price of money more expensive, with greater intensity in the euro area than in the United States, where rate hikes are already close to reaching their maximum limits.

Investors began to envision a benign scenario, in which inflation would have already peaked, leading to an easing of monetary policy. But the picture painted by central banks this week is one of rates that are going to remain high longer than expected and inflation that is frozen and may give a deceptive image of moderation. Thus, increases in energy prices but not food, while price increases tend to be transferred to the labor market and aim to raise underlying inflation.

Markets have adjusted their interest rate forecasts higher following this week’s Fed and ECB meetings, but without much conviction. Jerome Powell and Christine Lagarde wanted to calm expectations of a rate cut in 2023, but even as investors adjusted their expectations to the new scenario, some reservations remained about whether the central banker would follow through with the harshness of their messaging. Will be able to. on whether a longer and deeper economic downturn than the expected technical contraction will force rates to fall sooner than expected.

Analysts believe that the ECB’s calculation of GDP growth in the euro zone in 2023 is too optimistic

Luke Bartholomew, senior economist at Aberdeen, believes that “it is not normal for Lagarde to try to guide markets in such a forceful way, which reflects the urgency of what the ECB wants to say. However, if the economy falls into a deeper recession than the ECB expects, we think it is unlikely to raise rates aggressively.” From the firm Federated Hermes they state that “the ECB feels that its credibility is at stake and, as a result, it is determined to err on the hard side, at the risk of exaggeration.” In fact, his message became more aggressive when he acknowledged that the Eurozone economy had entered a recession. In forecasts released this Thursday, Lagarde forecast a further contraction in GDP this quarter and the next, although the forecast for 2023 continues for GDP growth of 0.5%.

Central banks were already wrong more than a year ago when they insisted that the first signs of a rise in inflation were a transitory phenomenon, typical of a return to activity after a drastic pause caused by the pandemic. But inflation has shown persistence capable of thwarting all calculations from the war in Ukraine and its impact on energy prices. The question now is whether the central banks are correct in their forecast for the economy, whether the recession will be mild, shallow and short-lived, as Lagarde has predicted, or if it will be worse, which will test their determination to keep raising rates. Will do The tradeoff between growth and inflation – undoubtedly tilted in favor of price stability – is getting worse.

Nomura analysts warn that the ECB is overly optimistic in its growth forecasts and believe that last Thursday’s hike of 75 basis points would have been “more than justified by Lagarde’s hawkish comments and inflation forecasts”. The Japanese firm forecast deposit rates would reach a maximum of 3.5% in June 2023, with a 50 basis point increase in February, another increase of 50 basis points in March as well – compared to its previous estimate of 25 – and two more More than a quarter point in May and June.

At Goldman Sachs, they also expect a 50 basis point rate hike in the euro area at the ECB’s next meeting on February 2, and they acknowledge that they will have to adjust their forecast of the terminal rate upward for interest rates. . Deposit 3%. In the market, futures put the terminal rate of rates in the euro zone at 3.25% from the current 2%.

A rate hike would be undeniable, but according to experts, the bigger market risk for next year is that central banks go too far with their hikes. “It seems that financial markets and the ECB still live in two different worlds,” explains Sylvain Brouer, chief EMEA economist at S&P Global Ratings, adding that investors discounted Lagarde’s relative optimism from the recession. “If the market outlook is correct, the ECB must be very careful in its upcoming decisions on rates and the withdrawal of liquidity if it does not want to plunge the European economy into an unnecessarily longer and deeper recession than its forecasts have predicted. A signal sent by the RBI with a flat or inverted rate curve should set off alarm bells from the Governing Council”, he explains.

Powell much closer to cap on rate level than Lagarde

These warnings also apply to the Fed. Powell is now close to a monetary policy mistake for Julius Baer chief economist David Kohl. “We share the view that the US economy is well prepared for monetary policy tightening. At the same time, we think that further tightening of monetary policy is unnecessary and would be a mistake,” he defended. Kohl points out that with rates in the US now at 4.25%-4.5% – after a half-point increase last week -, the price of money would be 200 basis points above a level already considered neutral, with the economy neither stimulated. Nor forced.

The Fed now forecasts interest rates to rise to 5.1% in 2023, according to its own forecast, a level higher than market forecasts. Thus, futures suggest that the range will be 4.8% in the middle of the year and it will fall to 4.2% in January 2024.

The Federal Reserve is therefore much closer to completing its tightening cycle of monetary policy than the ECB. Dutch central bank president Klaas Knut, a well-known hawk on the ECB’s Governing Council, noted on Friday that “the US is close to the tipping point of raising interest rates, but we have yet to hike further. Part of the rate differential will disappear”. ” Lagarde distanced herself from the analogy with the Fed on Thursday, insisting that the ECB is far from a policy turn.

In the future, and as warned by German manager Flossbach von Storch, the major challenge for the ECB will be the asymmetry within the eurozone. In November, the year-on-year inflation rate in Spain was 6.8% while in Estonia it reached 21.4%. However the rise in rates and rise in mortgage prices will affect all Europeans equally.

New code of conduct for senior ECB officials

Investment. The ECB will prohibit its senior executives from making any investments in specific shares or bonds, so private financial operations will have to be limited to mutual or listed investment funds and, in addition, have a “highly diversified” strategy. This Friday unit. The new rules will update the ECB’s code of conduct, which applies to all its senior officials. Under the previous rules, investment was allowed at the individual level, though it was recommended that it be delegated to the manager.

surveillance. Employees who hold individual stocks or bonds will be able to keep them, but not make any additional purchases. Its sale will be subject to approval by the Ethics Committee of the ECB.

Times of National
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