Hawkish Central Banks Highlight Persistence of Tight Monetary Policy

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Eurozone Market Update

In June, the ECB raised interest rates by 25 bps, taking the deposit rate to 3.5%. The Governing Council also confirmed discontinuing the asset purchase programme (APP) reinvestment in July. Annual Eurozone core inflation rose to 5.4 from 5.3 but printed below consensus. Eurozone composite PMI fell to 50.3, 2.2 points below expectations, dragged lower by manufacturing and services. Eurosystem staff projections provided a hawkish tilt with inflation expectations revised higher, indicating core inflation will remain above target until the end of 2025. President Lagarde provided strong forward guidance that barring a material change, rates will likely rise in July. While there is no wage price spiral, Lagarde highlighted unit labour costs were a critical driver of the upward inflation revisions.

Euro Short Term Rates

_{Source: Bloomberg, data as at 30 June 2023}

UK Market Update

The BoE increased the policy rate by 50 bps in June to 5%. This surprised markets as many believed the Bank would wait until August for more aggressive action and use June’s meeting to prepare the market for the step back up to 50 bps. However, considering the recent upside surprises in wage growth and core inflation, most can rationalise the decision to be more assertive (see Chart of the Month). While emphasising the BoE is not signalling future rate decisions, Governor Andrew Bailey stressed that the current levels of wage increases cannot continue. Indeed, the labour market remained robust and wage data continued to print above expectations. Inflation also continued to surprise on the upside, with annual headline (8.7%) and core (7.1%) CPI beating expectations of 8.4% and 6.8%, respectively.

GBP Short Term Rates

_{Source: Bloomberg, data as at 30 June 2023}

US Market Update

June saw the Fed pause its rate hikes, maintaining the Fed Funds target range of 5% to 5.25%. Federal Open Market Committee (FOMC) participants hinted at a pause to assess the cumulative impact of monetary policy tightening, despite a strong labour market and still unacceptably high inflation. The ‘Dot Plot’ of median FOMC expectations showed 50 bps of additional hikes by year-end, and 100 bps of cuts starting in 2024. Chair Jerome Powell posited that while monetary policy tightening had “covered a lot of ground…the full effects…are yet to be felt.” Powell clarified that he expects the July FOMC meeting to be ‘live’ for potential hike and clarified that a “pause is [a] continuation of moderating [the] pace of hikes.”

USD Short Term Rates

_{Source: Bloomberg, data as at 30 June 2023}

Looking Ahead

While the FOMC, ECB and BoE delivered harmonised 25 bps hikes in May, the split between no hike, 25 bps and 50 bps in June showed that while they may still be on the same path, we could be entering a period of divergent policy increments. Central banks remain hawkish across the board as elevated core inflation continues to be their main focus. The BoE’s position is particularly precarious, as its core inflation momentum has caused the market to reprice the UK’s peak policy rate significantly. Wages are the key driver of core prices, with the BoE expressing caution about a wage price spiral, and the ECB mentioned the possibility of one. We maintain that the market is too optimistic about rate cuts in 2024 and should focus more on the persistence of tight monetary policy.

Chart of the Month: UK markets show resilience to high interest rates

LDI = Liability Driven Investing
SONIA = Sterling Overnight Index Average
_{Source: Bloomberg, data as at 30 June 2023}

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