Global central banks pushing back on rate cut expectations; why?

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More and more data points to the fact that tight lending and monetary policy have peaked and are now effectively bringing down inflation.

But as major central banks prepare to announce decisions next week, the Federal Reserve and Bank of England won’t want to support the recent surge in rate-cut expectations in financial markets.

On Friday, the Reserve Bank of India sounded ‘hawkish’ compared to predictions for hints of policy easing.

The reason is concerns over elevated food inflation.

The other reason is they don’t want to falter again as they did in 2021 when they called surging inflation “transitory.”

After six consecutive rate hikes between April 2022 and February this year, the Reserve Bank of India has kept monetary policy on hold.

The likelihood the central bank hints at rate cuts was factored in before today’s decision and comments from Governor Shaktikanta Das.

But RBI more or less dashed those expectations by sounding hawkish in its assessment of inflation.

Governor Das said rate cuts were off the table.

The deputy chief economist for emerging markets at Capital Economics, Shilan Shah, said, “The economy is performing exceptionally well, which limits any immediate need for looser policy.”

US: Pushback from the Fed

At the FOMC meeting next week, it is generally anticipated that the Federal Reserve will maintain the Fed funds target range at 5.25–5.5 per cent.

Key Federal Reserve officials actively support the theory that monetary policy is sufficiently tight to drive inflation sustainably down to 2 per cent in the upcoming months, as evidenced by softer activity, cooling labour data, and benign inflation prints.

James Knightley, Chief International Economist at ING Markets, said, “The bigger story is likely to be contained in the individual Fed member forecasts – how far will they look to back the market perceptions that major rate cuts are on their way?”

“We strongly suspect there will be a lot of pushback here,” he added.

Global central banks want to be ahead of the curve after dismissing rising price pressures as “transitory” in 2021.

Back then, the world underestimated surging inflation and had to react more aggressively when price pressures soared to multi-decade highs globally.

But bets in recent months have increased for global interest rates to ease next year.

Still, central banks worldwide will be in pain to stave off those expectations and, at the same time, stay away from sounding the alarm bells.

“We think the Fed will eventually shift to a more dovish stance, but this may not come until late in the first quarter of 2024,” said ING’s Knightley.

“The US economy continues to perform well for now, and the jobs market remains tight. However, there is growing evidence that the Federal Reserve’s interest rate increases and the associated tightening of credit conditions are starting to have the desired effect. We look for 150bp of rate cuts in 2024, with a further 100bp in early 2025,” he added.

Bank of England to push back, too

With the “higher for longer” mantra that central banks have been hammering home for months, financial markets are quickly giving up.

The Bank of England (BoE) has yet to be as active with its market repricing.

However, the BoE is beginning to raise the alarm with three rate cuts already scheduled for 2024.

Recently, Governor Andrew Bailey stated that he is “against assumptions that we’re talking about cutting interest rates”.

Those remarks came after the Bank strengthened its guidance in November, indicating that it anticipated rates to remain restrictive for “an extended period of time”.

The fact that the data is at least beginning to trend in the right direction will also satisfy the BoE.

Inflation in services fell short of the Bank’s most recent estimate. The market’s assumption that the BoE will start cutting rates later than its European counterparts may be accurate.

Could the Bank take a step further and declare in the announcement next week that markets are overpricing the 2024 easing?

It has yet to make a statement like this since November 2022, at a volatile period in the market.

“Policymakers may be uneasy about the recent repricing of UK rate expectations, but central banks globally have learned the hard way over the last couple of years that trying to predict and commit to future policy, with relative certainty, is a fool’s game,” said James Smith, Developed Markets Economist at ING.

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