On the 14th September 2023 the ECB, (European Central Bank), hiked its key interest rate for the 10th time in 14 months to 4%, a record high. The ECB then went on to signal that this was probably going to be the last interest rate rise in the continuing fight against inflation. The ECB (covering 20 countries that share the euro) revised upwards its forecast for inflation, suggesting that it would return to 2% in the coming two years and at the same time revised downwards its forecast for economic growth.
When the ECB changed their monetary policy to quantitative tightening in July 2022, the key interest rate was at a record low of minus 0.5%, which meant that any bank depositing cash had to pay the ECB. Today, after the September 14th rate increase the ECB now pays banks 4% for depositing cash.
Although the ECB has signalled this is the end of interest hikes, their President Christine Lagarde said interest rates would remain high or restrictive for some time to come, adding that the ECB cannot completely rule out another increase in interest rates even though rates currently stand at their peak.
However, Yannis Stournaras, an ECB Governing Council Member, was quoted as saying, “The ECB as a next move was more likely to lower borrowing costs rather than raise them further”, one of the clearest remarks from the ECB confirming interest rates had probably reached their peak. At the Dutch Central Bank, President Klaas Knot seemed to echo Mr Stournaras’s words that he does not expect any change in the short-term, and added that he expects inflation to return to 2% in 2025.
Indeed, the Vice President of the ECB Luis de Guindos said that he hoped additional quantitative tightening would not be necessary. Furthermore, the Governor of the Croatian National Bank and ECB Council Member Boris Vujcic said that this was probably the last in a long line of monetary tightening. It would appear, therefore, that if inflation moderates the general consensus is that this will be the last in interest rate hikes by the ECB. However, taking a contradictory stance is Bundesbank President Joachim Nagel, who said that as inflation stubbornly remains at 5%, it is too soon to say if rates have peaked.
The next question is how long will borrowing rates remain high? Investors and economists are already pencilling in spring of 2024 for the first rate cut, especially as the Eurozone economy is showing signs of increasing weakness. Experts advise that the latest increase by the ECB is slowing down the economies in all European countries with a number of central banks advising they will keep rates as high as needed to defeat inflation.
However, some ECB council members argue that further rate rises may well kill the economy, especially as data shows continuing contraction in services and manufacturing. Indeed, some experts are now predicting a possible recession in the euro area, confirming that economic weakness is not just confined to Germany, which has suffered from high energy prices.
With regard to Germany, in the week 18th – 22nd September 2023, German bonds fell dramatically which sent the cost of government borrowings to their highest level for 10 years, as investors and traders decided that Eurozone interest rates will remain at an elevated level with the ECB keeping policy tight for some time to come. Indeed, longer maturity bonds were badly hit in a sell-off across Europe, with experts advising that in the short-end debt market investors can achieve returns that are risk free close to circa 4%.
Meanwhile, across the Atlantic Ocean on 20th September 2023, the US Federal Reserve kept its benchmark interest rate unchanged but at the same time signalling there may be one more interest rate hike in 2023 with borrowing costs staying at an elevated level for longer. The FOMC, (Federal Open Market Committee- the US Central Bank’s policy setting committee), who held rates steady at 5.25 – 5.50%, were quoted as saying, “Officials will determine the extent of additional policy firming that may be appropriate”. After the announcement, yields rose to a decade high on two-, five- and ten-year government bonds as treasuries were sold off.
Chairman of the Federal Reserve Jerome Powell went on to clarify by releasing a statement saying, “Officials are prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective”. He went on to say that we think we are fairly close to where we need to be and that the Federal Reserve is committed to a monetary policy that is sufficiently restrictive to bring inflation down to our goal of 2%.
However, quarterly projections that were updated showed that out of 19 officials in the FOMC, 12 were in favour of another rate hike this year reflecting their desire to ensure the deceleration of inflation. Their projections for the reduction of inflation show that the country will have to wait three years to the end of 2026 where they will see a projected federal fund rate of 2.9%, with the rate being 3.9% at the end of 2025.
It is interesting to note that traders often take up a contrary position to the Federal Reserve, as when they signal that interest rates will not be dropping anytime in the near future, the financial markets take the opposite view by laying bets to the contrary. These interactions have taken place over the last 18 months, none more so than on the Wednesday during the week 18th September – 22nd September 2023 when the Federal Reserve published forecasts showing that at the end of Q4 2023 benchmark overnight interest rates would be 5.6%, which implies another interest rate rise before Christmas.
They also announced that their policy rate for the end of Q4 2024 would be at least 5.1%, a full 50 basis points higher than announced three months ago. However, in the financial markets interest rate contracts are continuing to price in a 50/50 chance of increased quantitative tightening in 2023, where they see a 4.65% policy rate by the end of Q4 2024.
The US economy continues to defy predictions and remains resilient with consumer spending and the labour market remaining steady while core inflation, (all data except for food and energy) has continued a steady decline. However, policymakers will be aware of the 30% increase in oil prices since June of this year plus the resumption in October of the student-loan payments* that will reduce spending power of consumers. They will also be aware of the impending shutdown of the US Federal Government.
*Student-Loan Payments – After a moratorium on Federal student loan payments, these will resume after 3 years in October with interest starting to accrue on 1st September 2023. There are circa 40 Million Americans with federal student debt averaging roughly USD37,000 per borrower.
Once again politicians cannot agree on the Federal Budget and the government is heading for a shut down in the coming October. Obviously the United States losing the coveted AAA rating and being downgraded to AA+ means nothing to politicians. Government funding shuts down October 1st and a shutdown will effectively begin at 12.01am. This will have a direct impact on the economy, with the travel sector alone expected to lose USD140 Million per day. Some experts predict that economic growth will reduce by 0.2% every week, and the longer the shutdown goes on, there is a bigger probability of interest rates being impacted. It can only be hoped that the hardliners in the Republican Party can come to an agreement with their democratic counterparties.
Returning across the Atlantic Ocean in London on 21st September 2023, the Bank of England finally brought to a halt (albeit temporary), a highly aggressive cycle of interest rate rises, not seen for 30 years due to signs that the economy may be slipping into recession. Ending 14 successive interest rate rises that started in December 2021, (rates were 0.1%), the Bank of England held their key rate steady at 5.25%. It was a close-run vote with four members of the MPC (Monetary Policy Committee) wanting to raise interest rates to 5.5% and five members voting to leave the rate unchanged along with the Governor (Andrew Bailey) who had the casting vote.
However, as inflation remains three times above the Bank of England target of 2%, they signalled that policy would change if inflation did not fall as expected, with the MPC forecasting that the target would be hit in Q2 2025. Governor Bailey said following the decision, inflation had fallen decisively, but they would continue to take decisions to ensure inflation falls to the target figure. Reiterating its former guidance, the MPC said that interest rates would remain restrictive for a sufficiently long period implying in tandem with other central banks that interest rates will remain high for the time being.
Experts such as economists and investors are already betting on interest rates having peaked, with the pound falling against the dollar, its weakest since March 2023 with currency traders slimming down bets on further interest rate rises. During the week 18th – 22nd of September 2023, experts announced that sterling traded weaker down 4% against the dollar at USD1.2239 the biggest decline across the Group-of-10 Peers* over a period of one month.
*Group-of-10 Peers – Not to be confused with the G7 or G20, this group consists of Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the United Kingdom, And the United States, (Switzerland enjoys a minor role within this group). This group of countries have agreed to participate in the General Arrangements to Borrow (GAB), which is a supplementary borrowing arrangement that can be invoked if resources from the IMF are estimated to be below a members’ needs, (e.g., to provide more funds for utilisation by the IMF).
It would appear that interest rates have reached their zenith with the Federal Reserve, the Bank of England and the European Central Bank, but with all three suggesting there may or may not be another interest rate hike, rates will stay high certainly for the time being. The Bank of England appears to be the prime candidate to raise interest rates one more time in 2023, with the Federal Reserve a close second with suggestions they may raise rates one more time.