Central Banks Continue to Tighten Policy, But Dark Clouds Loom

Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.

Eurozone Market Update

As expected, the European Central Bank (ECB) left policy rates unchanged in June and announced it would end purchases under its asset purchasing programme as of 1st July. Later, the bank held an emergency meeting to discuss concerns over Eurozone fragmentation. With regard to rates, the ECB indicated it would begin hiking by 25 basis points (bps) at its July meeting. There was a hawkish surprise in the language around the September meeting, however, implying that a more significant move of 50 bps was their baseline before reverting to a “gradual but sustained” path for normalisation. Currently, as measured by overnight index swaps, the implied interest rate in the Eurozone will be non-negative by Q3 and at 1.59% by year-end.

UK Market Update

The Bank of England (BoE) opted to continue its trend of 25 basis points rate hikes in June, taking the base rate up to 1.25%. Notably, the Monetary Policy Committee vote was split 6-3, with some preferring a more extreme hike. The meeting minutes took on a more hawkish tone, with inflation expected to reach above 11% by the end of the year, peaking in October. The BoE indicated that they would act “forcefully” on inflation, a shift from previous language. Data throughout the month reinforced growing fears of recession, with GDP contracting in April by 0.3%, missing estimates for the second month in a row. Core inflation was slightly weaker than anticipated at 5.9% (versus the expected 6%).

US Market Update

The Federal Open Market Committee surprised the market in June by increasing interest rates by 75 bps, having previously stated they would repeat the previous 50 bps hike to combat inflation. The more aggressive hike came after the headline Consumer Price Index rose to 8.6% year-on-year, its highest peak since December 1981. Comments from the Fed continue to be highly hawkish, with several speakers continuing to indicate that more 75 bps hikes are needed at upcoming meetings to bring down inflation. Current Fed Fund Futures contracts are pricing in a 77% probability of a 75 bps hike in July and a 100% probability of a 50 bps hike in September.

Global Outlook

The main focus for July will be on the Fed and ECB meetings at the end of the month. We still fully expect rate hikes from both central banks in July, but the magnitude of the hikes remains flexible and will be data-dependent until the meeting, creating uncertainty. We continue to believe that increasing fears of a recession will prevent central banks from hiking as much as priced by the market. This will be a focal point for the second half of 2022. The market now expects central banks to begin cutting rates in late 2023 or early 2024 (see Chart of the Month), which supports our long-term view that rate hikes will be front-loaded, leading to a different hiking cycle than we have previously experienced.

Chart of the Month: Markets price in central bank rate cuts for 2023/24

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