ECB, Fed and BoE Hawks Ponder Higher Rate Hikes

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UK Market Update

To combat elevated inflation, which is expected to reach 13% in Q4 2022, the Bank of England (BoE) raised interest rates by 50 basis points (bps) in August, the biggest jump since 1995. The bank also adjusted its economic outlook, now anticipating a recession to begin in 2022 and continue throughout 2023 due to soaring energy prices and the cost-of-living crisis. Data releases supported the more drastic August hike, as Q2 UK GDP (-0.1%) beat the expected -0.2%. CPI inflation of 10.1% was higher than the 9.8% expected, while the July jobs report showed 73,000 new jobs created, exceeding the anticipated 25,000 figure. The implied year-end UK interest rate rose from 2.62% on 1 August to 3.47% by month-end (see Chart of the Month).

Eurozone Market Update

In the eurozone, energy supply risks resulting in elevated inflation and declining growth have been a significant focus, alongside the reaction of the European Central Bank (ECB) policy response. Despite the announcement of the ECB’s Transmission Protection Instrument, concerns remain over support for peripheral states, particularly with the Italian election next month. Attention remains on the new leadership’s fiscal policy as the ECB works to balance the rising rate environment in both the core and peripheral states. Data showed continued high inflation, as eurozone consumer price inflation increased to 8.9% in August and is expected to rise above 10% in October. As measured by overnight index swaps, the implied year-end eurozone interest rate will be 1.61%, an increase of 74 bps over the month.

US Market Update

Federal Reserve officials continued a hawkish tone on future rate hikes at their annual Jackson Hole meeting. Chair Jerome Powell stressed the Fed’s commitment to driving inflation lower by holding rates higher for longer, and he noted that one decent inflation reading does not mean the battle is won. This followed a report of flat inflation in July from the previous month and a 0.3% rise in core inflation, the slowest monthly increase since March. Year-over-year, inflation fell to 8.5% from 9.1%, with core inflation unchanged at 5.9%. The labour market is tight, with unemployment in July falling to 3.5%, while non-farm payrolls added 528,000 new jobs, more than double the 250,000 expected. Fed fund future contracts are pricing in a 75% probability of a 75 bps hike in September.

Looking Ahead

The ECB, Fed and BoE all meet in September. Given the more hawkish tone from members of all three towards the end of August, there is an increased risk they will deliver more extensive rate hikes than we expected a month ago, when the base case was 50 bps hikes for each central bank. With inflation remaining elevated globally and growth and labour markets currently remaining robust, central banks will likely continue to raise rates until they see the economic data change. Hikes of 75 bps from all three central banks is an increasing risk case. In the UK, the new Conservative Party leader will be announced early in September. We also expect the announcement of a significant fiscal stimulus package to follow rapidly to assist people, with the energy price cap increasing by 80% in October and reducing the need for the BoE to hike rates to levels implied by market forwards.

Chart of the Month: Hawkish comments from all three central banks drive up year-end interest rate expectations

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