Hike or Pause? Central Banks’ Data-Driven Dilemma

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

Eurozone Market Update

The ECB unanimously voted to raise its three key interest rates by 25 bps in July, taking the deposit rate to 3.75%, the highest since 2001. Following the announcement, President Christine Lagarde firmly ruled out the prospects of a cut at the September meeting and stressed multiple times that the ECB could hike or pause at that time. This gives the central bank optionality and underscores the importance of incoming financial data. The euro area composite Purchasing Managers Index (PMI) was 48.9 in July, below expectations of 49.6, as both manufacturing and services components softened for the third consecutive month. The most significant composite PMI declines were in Germany (48.3, down 2.3) and France (46.6, down 0.6).

Euro Short Term Rates

_{Source: Bloomberg, data as at 31 July 2023}

UK Market Update

July’s UK inflation came in softer than expected, with annual headline CPI at 7.9% and annual core inflation at 6.9% (see Chart of the Month). This divided market views for August’s BoE meeting, with some now leaning towards a 25 bps hike instead of 50 bps. UK labour market data showed mixed signals, with employment rising by 102,000 in the three months from May, as wage growth continued accelerating. The BoE’s Decision Maker Panel survey for June indicated a rise in three-year ahead inflation expectations from 3.4% to 3.7%. PMI data slowed for the third consecutive month, indicating softening demand in the service sector due to the impact of higher interest rates.

GBP Short Term Rates

_{Source: Bloomberg, data as at 31 July 2023}

US Market Update

In July, the Federal Open Market Committee (FOMC) voted unanimously to raise the Fed Funds target range by 25 bps, to 5.25% to 5.5%. This move was anticipated due to comments from FOMC participants noting strong labour market conditions and unacceptably high inflation. Chair Jerome Powell maintained the same language regarding the banking system but clarified the Fed would assess the implication of additional data on monetary policy. US annual headline inflation decreased from 4.0% to 3.0%, and core inflation declined from 5.3% to 4.8%. Core goods prices fell 0.1%, and core service prices rose only 0.3%, the softest since September 2021. The data indicates there may be a broader path to a soft landing.

USD Short Term Rates

_{Source: Bloomberg, data as at 31 July 2023}

Looking Ahead

We believe we are in a stage of the hiking cycle where we will see divergent policy “increments” between central banks, but they are on the same path. The Fed introduced the “skip” concept in June, while the ECB shifted to a meeting-by-meeting approach in July. All three banks approach the peaks of their monetary hiking cycles, cautious of existing risks. The Fed leads, followed by the ECB, while the BoE’s position remains unclear due to communication issues. Economic growth has stayed surprisingly resilient even as PMI data has been flashing amber, while labour markets remain tight. Headline inflation gives hope for a downward trend, but the core remains persistent. The burden of proof will be on the incoming economic data. Strong data may lead to continued hiking. Softer data won’t necessarily imply easing but could prompt a pause for assessment in the fight against inflation.

Chart of the Month: ECB and BOE Fall Behind in Efforts to Curb Inflation

_{Source: Bloomberg, data as at 31 July 2023}

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