Daily Management Review

After A Massive Rate Hike Run, Central Banks In Europe Stop For Breath, But They Are Faced With A "Triple Dilemma"


After A Massive Rate Hike Run, Central Banks In Europe Stop For Breath, But They Are Faced With A "Triple Dilemma"
European households and companies continue to experience high inflation, and the region's central banks have not yet declared success in bringing it down to target.
However, September saw a shift in the tone of their communications as some central banks paused interest rate increases after almost two years, while others seemed to be approaching peak rates. Due to pressure on economic growth, this has caused the market to focus on how long rates will be held at current levels.
The decisions made this month have demonstrated that "all central banks are coping with the same triple dilemma: how to balance between slowing economies, still too high inflation, and the delayed impact of unprecedented rate hikes," according to Carsten Brzeski, global head of macro at Dutch bank ING.
“The other common theme is, of course, that in all regions interest rates are very close to peak, which complicates the above described dilemma.”
He added that the recent increase in oil prices is a problem because it could fuel inflation, slow economic growth, and make it harder to predict future interest rate changes.
After 14 straight rate increases, the Bank of England decided to stop moving the interest rate and maintain its key policy rate at 5.25%.
Five members of the Monetary Policy Committee voted to hold, while four voted for a further 25 basis point increase. The August inflation data, which showed headline year-on-year inflation of 6.7%, significantly above the BOE's 2% objective but below a 7% projection, may have swung the decision.
In addition, the central bank noted stable wage growth, signs of loosening in the labour market, and weaker second-half economic growth. In July, the UK economy contracted by 0.5% as a result of a seven-year high in late mortgage payments.
While BOE Governor Andrew Bailey stated that the committee would be "watching closely to see if further increases are needed," many economists stated that they anticipated this to be the bank's peak rate.
Paul Dales, chief U.K. economist at Capital Economics, said that, like the U.S. Federal Reserve — which also held rates steady in September — the BOE “wants the markets to believe in the high for long narrative.”
“The Bank doesn’t want the markets to decide that a peak in rates will be soon followed by rate cuts, which would loosen financial conditions and undermine its attempts to quash inflation,” Dales said in a note on Thursday.
According to Capital Economics, rate reduction will start in late 2024 and will be "further and faster than widely expected," but according to HSBC experts, there won't be any decreases during the next 15 months. In contrast, Simon French, chief economist at Panmure Gordon, thinks it is too early to make any predictions with any degree of certainty about when the first interest rate decrease will occur because there aren't any "parameters for easing."
For the first time since March 2022, the Swiss National Bank decided against raising interest rates, noting in a statement that "the significant tightening of monetary policy over recent quarters is countering remaining inflationary pressure."
In August, Switzerland's inflation rate of 1.6% was within the national goal range of 0% to 2%.
The struggle against inflation, according to SNB Governor Thomas Jordan, is still ongoing, and the Swiss central bank will continue to keep an eye on inflationary forces. Jordan emphasised that this might necessitate tightening even further in December.
Given this continuous prudence and the lack of any signs of rate decreases, analysts referred to the most recent SNB decision as a "hawkish pause" even though Switzerland's economy slowed down in the second quarter. The nation's economy is anticipated to rise by 1% annually on average.
In 2023 and 2024, the SNB expects Swiss inflation to average 2.2%, before falling to 1.9% in 2025, providing its policy rate stays at its current level of 1.75%.
On the other hand, the European Central Bank's 25 basis point rate increase on September 14 was characterised by some as a "dovish hike" because it implied rates may have peaked.
“The Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” the ECB said in a statement, adding that rates would be “set at sufficiently restrictive levels for as long as necessary.”
In contrast to the over 2% growth predicted for the U.S. in 2023, the ECB predicts barely 0.7% growth in the euro zone this year and 1% next year.
Market pricing points to a more pessimistic economic forecast and the likelihood that the central bank would be forced to make rate reduction by the middle of next year as a result.
The euro's performance against the dollar has dropped 1.7% so far this month, which is its lowest showing since February. Despite interest rate increases often increasing a currency's worth, the drop nonetheless occurred.
Norway and Sweden in northern Europe chose to raise interest rates on Thursday, indicating that additional tightening may be on the horizon.
However, there was also a hint of peak rates in these decisions. Ida Wolden Bache, the governor of Norway's Norges Bank, stated that there would "likely be one additional policy rate hike, most probably in December."
"There will probably need to maintain a tight stance for some time ahead," Bache continued.
In August, the headline inflation rate in Norway was 4.8%, while the core inflation rate was 6.3%.
As opposed to the current 4.25%, the Norges Bank estimate now predicts a policy rate of 4.5% through 2024.
It noted uncertainties in its outlook, as did other central banks, and noted that inflationary pressures and a weak krona could lead it to raise rates further.
Meanwhile, a lower rate might result from a "more pronounced slowdown" in the economy or a sharp decrease in inflation.
Separately, as it increased its benchmark rate to 4%, Sweden's Riksbank declared that inflation was still too high and that monetary policy needed to be tightened even more.
In recent months, the value of the Swedish krona relative to the euro has fallen to record lows. In order to combat what it perceives to be an undervaluation, the Swedish central bank announced Thursday that it will hedge a portion of its foreign exchange reserves.
Sweden has also seen a sharp decline in the housing market, and according to projections from Riksbank, the country's economy will fall by 0.8% this year and 0.1% the following year.
Because of this, Capital Economics forecast rate reductions "sooner and faster" than the Swedish central bank had indicated, before the middle of next year.
However, given the future difficulties of decisions for all central banks, ING's Brzeski cautioned that the dual dynamics of inflationary pressures and poorer growth could produce a different outcome.
“Central banks most concerned about their credibility and the longer term impact on inflation expectations, like the ECB and the Riksbank, could end up continuing hiking rates,” he said.