Financial stability in the spotlight as central banks gear up to hike rates again

[LONDON] The US, European Union (EU) and the UK are all expected to announce a hike in interest rates this week, with analysts keeping a close eye on whether these will be higher than the consensus forecasts.

Since October, global equities, bonds and commodities have rallied on hopes that inflation may have finally peaked. The market bulls are hoping that central banks will once again pursue easier monetary conditions, and that interest rates will reach a peak later this year and then begin to fall in 2024.

The bears, on the other hand, warn that central banks are raising interest rates at a difficult time when many economies are on the brink of recession or are already experiencing a downturn. The rate hikes will worsen the slowdown and could potentially cause a financial crash, they say.

Neil Shearing, the group chief economist at Capital Economists, said that central banks face “enormously complex and uncertain outlooks” in a post-pandemic and fractured global economy. “They must focus on their core objectives of maintaining both price stability and financial stability,” he said.

The US Federal Reserve Board’s first meeting of the year began on Tuesday (Jan 31), and after seven rate rises in 2022, economists and traders are predicting another 25-basis points rise at the end of the two-day session that would take the federal funds rate to the 4.5 per cent to 4.75 per cent range.

Fed officials have already stated their intention to lift the rate to above 5 per cent by the middle of 2023 and keep it at that level until inflation – which stood at 6.5 per cent in December – falls closer to the Fed’s long-term target of 2 per cent.

A Goldman Sachs’ survey of 400 clients in January found that 57 per cent of respondents expects the US to fall into a recession this year, and that US inflation would moderate to 3 to 4 per cent by the end of the year. They also feel that the Fed will stop raising interest rates only when they reach 5.25 per cent, before cutting rates sometime in 2024.

On Wednesday, the Bank of England (BOE) continues with its attack on inflation which was a whopping 10.5 per cent in December, much higher than its EU competitors.

The BOE begins a two-day meeting at a time when wages are rising at the fastest pace in 22 years. There are still intermittent strikes involving nurses, firefighters, teachers and others that will aggravate the wage price spiral, say economists.

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And on Thursday, the European Central Bank (ECB) is expected to raise rates by half-a-percentage point to 3 per cent. “Interest rates will have to rise significantly at a steady pace to reach levels that are sufficiently restrictive,” said ECB president Christine Lagarde earlier this week. “We will stay at those levels for as long as necessary.” About three quarters of the respondents of the Goldman survey predicted a recession in the eurozone this year, and that inflation would fall to 3.6 per cent by December 2023, having peaked at around 10 per cent in November 2022.

Germany – the largest economy in Europe – saw an unexpected contraction of 0.2 per cent in the final three months of 2022, fueling fears that the manufacturing powerhouse could be on the cusp of a recession.

Carsten Brzeski, global head of macro economics at Dutch bank ING, noted that industrial production in Germany is still about 5 per cent below what it was before the pandemic.

“Consumer confidence, despite some recent improvement, is still close to historic lows, and the loss of purchasing power will continue in 2023. A winter recession remains a base case for the German economy,” he said.