Central Banks Hold Rates as Financial Tightening Takes Grip

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Eurozone Market Update

Following 10 straight rate hikes, the ECB did not change its monetary policy in October, leaving deposit facility rates at 4%. The ECB’s accompanying statement reiterated its data-dependent approach and the expectation that it must maintain the current rate for a sufficiently long time so that inflation returns to its 2% target over the medium-term. The ECB has consistently pushed back on any talk of rate cuts, characterising this as extremely premature. Annual eurozone inflation fell to 2.9% in October, while core inflation remains high at 4.2%. Third quarter GDP of -0.1% missed market expectations of 0%, reflecting stagnating economic activity. October’s flash composite Purchasing Managers' Index (PMI) of 46.5 was down from 47.2 September and below the consensus of 47.4, primarily due to softening demand conditions.

Euro Short Term Rates

_{Source: Bloomberg, data as of 31 October 2023}

UK Market Update

Inflation in the UK remains sticky, with annual Consumer Price Index inflation in September at 6.7%, unchanged from August and above the consensus of 6.6%. Core inflation was 6.1%, down from August’s 6.2% but also above consensus of 6%. The data looked sufficiently well-behaved to allow the BoE to vote 6-3 to remain on hold at 5.25%. Following a new trial method of calculations, UK employment fell by 82,000 from July to August, with the rate falling to 60.9% from 61.2%, helping to reduce the upward pressure on wages. While recovered modestly in August with a 0.2% monthly gain, in line with expectations, composite PMI hit 48.6, up 0.1 from September.

GBP Short Term Rates

_{Source: Bloomberg, data as of 31 October 2023}

US Market Update

As expected, the FOMC left the target range for the federal funds rate unchanged at 5.25-5.5%. The Fed’s preferred inflation gauge, the Personal Consumption Expenditure Index showed a monthly 0.4% increase in overall prices in September, along with a 0.3% increase in the core index. The annual reading softened to an expected 3.7% from 3.9%. The advance estimate for third quarter GDP showed 4.9% growth, exceeding expectations of 4.5% and accelerating from 2.1% in the second quarter. Resilient consumer demand has driven US economic growth. The labour market continues to show signs of normalising, with non-farm payrolls widely expected to be 225,000 in October, slower than September’s 336,000 with the United Auto Workers strike causing around a 35,000 drag.

USD Short Term Rates

_{Source: Bloomberg, data as of 31 October 2023}

Looking Ahead

The three major central banks have now entered the holding phase of this monetary policy cycle. Using the analogy by Bank of France Governor François Villeroy that inflation is a disease and monetary policy is the medicine, we believe markets need the correct dosage but for a sufficiently long time. After the latest policy meetings, it is clear that central banks feel they have the correct dosage, but the duration we will need to take the medicine is a fluid debate. The market’s attention has recently shifted towards the longer end of the yield curve, as long bond yields rose sharply and the yield curve steepened aggressively. For money market investors, this causes a tightening impact on overall financial conditions. Additionally, tighter financial conditions will reduce central banks’ need to hike interest rates further, while significant tightening could even bring forward the cutting cycle.

Chart of the Month: Tighter Financial Conditions Suggest Rate Hiking Cycle Summit

_{Source: Bloomberg as of 31 October 2023}

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