Tag: Banking

Bank of England Interest Rates. Will They or Won’t They?

This month on June 20th the Bank of England’s MPC (Monetary Policy Committee) will meet and decide whether or not to keep interest rates on hold. At the last meeting of the MPC in May, interest rates were held at 5.25% for the sixth consecutive month and are still at their highest level since the Global Financial Crisis 2007 – 2009. The Bank of England’s target figure for inflation is 2% and in April it dipped to 2.3% which is a significant difference to March’s figure of 3.2%. 

However, experts in the financial markets had expected CPI (Consumer Price Index a common measure for headline inflation) for April to come in at 2.1%. However an important element in core inflation (does not include figures from food and energy sectors) came in at 5.9% in April down only 0.1% from March. All the above figures are supplied by the ONS (Office of National Statistics).

At the May meeting of the MPC Governor Andrew Bailey indicated that June may see a cut in interest rates though it is not a “fait accompli”, whilst also advising that like other central banks any cut in interest rates will be data driven. In mid-May financial markets suggested that an interest rate cut in June was circa 60% as measured by the overnight index swaps*, but since the release of the April inflation figures in late May that suggestion of an interest rate cut has subsided mainly in part due to sticky service inflation figures.

*Overnight Index Swaps – This is a financial bet on the direction of short-term interest rates and is a type of interest rate swap. In this case, it is typically a fixed for floating swap, where one party pays a fixed rate and receives the floating rate (linked to an overnight index) while the other party does the opposite. The overnight index for sterling is known as Sonia (replaced sterling Libor) and stands for Sterling Overnight Index Average.So will the Bank of England cut interest rates on June 20th? A number of experts suggest that an interest rate cut may not happen as the services sector inflation remains a problem and came in a lot hotter than market analysts predicted. Many experts feel that services inflation remains a critical part of the Bank of England’s thinking regarding inflation and interest rate cuts, and therefore the MPC may well decide to once again hold rates on June 20th.

Bad Debts and Chinese Banks 

Chinese banks have for years been reluctant to disclose any information on poorly performing loans or outright bad debts. They go to extraordinary lengths to hide these problems usually teaming up with an AMC (Asset Management Company)* where a transaction takes place that removes these loans from their books. So it came as a surprise when the Bank of Jiujiang on the 19th of March 2024 announced that profits for the previous year will probably fall by Circa 30% due to loans performing poorly.

*AMC’s – Chinese Asset Management Companies came into existence in 1998 and were established by the Ministry of Finance with the purpose of professionally managing third-party assets and was considered at that time to be a major landmark in the development of China’s financial system. It marked the transition from an unregulated environment to one where these specialist companies would operate with a defined set of financial parameters, regulations, and standards. 

The deal with AMC’s to hide these bad debts or poorly performing loans is as follows. First, the bank lends to the AMC who in return purchases the toxic loan(s) from the bank. Within the contract between the two parties it stipulates that the AMC will avoid any and all credit risks in regard to the toxic loans they are purchasing. Furthermore, the contract is also riddled with confidentiality clauses that keep either party from disclosing the arrangement, indeed sometimes even to courts. The result is that when the bank comes to declare their profits for the year to their investors they can produce a relatively clean balance sheet. 

For a long time the financial regulators were hoodwinked into believing that many of the banks were actually solving their bad debt problem, when in fact things were just getting worse and a number of experts suggest for literally hundreds of banks across China these toxic loans now represent a ticking time bomb. However, NAFR (The National Administration of Financial Regulation established 10th March 2023) the new financial regulatory body has caught on to these subterfuges and have been handing out fines left right and centre some in the region of Yuan200 Million (USD30 Million). Indeed, NAFR, with new heightened enforcement capabilities, are taking debt concealment much more seriously. 

Sadly for the banking institutions many AMC’s have themselves become distressed and are now reluctant to take more bad debt on board. Some decades ago China actually created four centrally controlled AMC’s to take on bad debt and are now currently struggling with one needing a bail out in 2021 to the tune of USD6.6 Billion. This is becoming a runaway freight train of bad debt, and with Bank of Jiujiang’s bad loan book increasing 700% between 2015 and the end of 2023, the whole banking system may soon become imperilled. 

The US Federal Reserve Releases New Scenario Stress Tests for Banks 

On Thursday 15th March 2024 the Federal Reserve issued new annual scenarios for stress tests for banks which will check their health under extreme economic shocks. These hypothetical shocks will include a collapse of real estate prices (40% drop in commercial real estate prices), and a jobless figure of 10% and will cover 32 banks including some with as little assets as USD100 Billion. Furthermore, the largest and most complex banks will be tested under a scenario where five hedge funds collapse at the same time. These stress scenarios represent the first tests since the collapse of Signature Banks and Silicon Valley in March 2023, which also led to the collapse of Credit Suisse Ag sparking concerns regarding the banking system as a whole.

Interestingly, the Federal Reserve has advised that these hypothetical scenarios will not affect or impact any of the tested banks capital adequacy requirements, pointing out that all results will not be issued until June 2024. These tests were first put in place post 2007 – 2009 Global Financial Crisis to ensure that banks in the United States could withstand further economic shocks and would allow banks to continue to lend to businesses and households despite any on-going shocks. These tests were a result of the Dodd-Frank Act (full name The Dodd-Frank Wall Street Reform and Consumer Protection Act),  that was enacted into law on the 21st of July 2010.

These tests are also very timely as there are growing worries in the financial markets regarding the exposure to commercial real estate (CRE), by a number of lenders, indeed, in January 2024 New York Community Bank sparked a drop in their share price having reported losses on bad CRE loans. The CRE sector (data released show small banks account for nearly 75% of outstanding loans in the CRE sector), has been facing a double whammy on the financial front with falling office occupation (due to widespread adoption of remote work) and high interest rates due to the Federal Reserve’s quantitative tightening measures. Interestingly, the 23 banks that were tested last year passed the tests with flying colours showing under the stress test scenarios they would lose a combined USD541 Billion but would still have double the amount of capital required.

In November, the United States will have their Presidential election most likely between Joe Biden (Democratic incumbent), and ex-President Donald Trump (Republican candidate). If Donald Trump is the victor, financial markets should be reminded that under his reign he signed into law a bill that amazingly reduced scrutiny over banks with assets under USD250 Billion, thus removing the requirement for many regional banks to submit stress testing plus reducing the amount of cash on their balance sheet usually required to protect against financial emergencies. If indeed he tries to do this again, we can only hope that insiders and financial authorities can prevail against this sort of action, otherwise we may have another financial disaster on our hands.

What is Bank Liquidity and Why is it Important?

The global financial crisis of 2007 – 2009 is a classic example of what happens when banks do not have enough cash to pay their debts, e.g., all those items on the liability side of their balance sheets. The reasons for the named financial crisis have been written about and discussed and dissected many times, which is why banks and other financial institutions have to adhere to very strict rules implement by their own authorities, on the back of the Basel iii Agreement*.

*The Basel iii Agreement was implemented in 2009 after the global financial meltdown, this agreement was produced by the Bank for International Settlements in conjunction with 28 central banks from across the globe. This agreement was designed to promote stability in the international banking sector and is a set of reforms to mitigate risk that require banks to keep certain levels of liquidity and maintain certain leverage ratios.

Simply put, banks are now required to maintain adequate cash or assets that can be easily turned into cash to meet the demands of depositors and financial market counterparty transactions in the event of an economic shock as seen in the global financial crisis and in events in March 2023. If liquidity rules are revoked in any way the results can be catastrophic as in the failures of Silicon Valley Bank and Signature Bank in March 2023, which also resulted in a run on other banks.

These failures were put down to President Donald Trump signing into law a bill that reduced scrutiny on banks with assets under USD250 Billion. This was down to the naive thought that with the extra liquidity now available to certain banks, they would be able to invest the funds profitably. What became clear, however, is that these financial rules make a huge difference, and are truly there to stop banks failing. 

Sadly, it appears that despite financial disasters, lessons are never learned and the next financial crisis could be just around the corner. If this is the case, it is hoped that throughout the major financial centres in the world, the banks have got their houses in order. Indeed, last year the vice president of the European Central Bank announced that banks in Europe had robust liquidity and high capital ratios and depositors would be safe in times of economic stress. Furthermore, recent announcements from the Federal Reserve in the United States advise they will stress test thirty two large lenders in scenarios under severe economic shock.

Today it appears that financial authorities and regulators have put in place (or are putting in place) sufficient regulations and stress tests that will satisfy the Basel iii agreement. However, extreme vigilance must be constant by authorities and political masters should be advised to keep well away from the rules and regulations of banking systems. Financial shocks always come as a surprise, so it is always important to make sure that the regulations implemented to protect society are followed to a letter, and not just undone the moment someone forgets about the last crisis.

What is Basis Trading and How Does it Affect the Treasury Bond Market?

Basis trading is a financial trading strategy regarding the purchase of a particular financial instrument or security (in this case Treasury Bonds) or commodity, and the sale of its related derivative. In this example, it is the purchase of a Treasury Bond and the sale of its related futures contract. In the treasury market, the trade is centred on the price differential between treasury bonds and their associated futures contracts.

From time to time, due to heavy purchasing of Treasury bond futures by insurance companies, institutional investors and pension funds*, the bond futures price rises above the price of the underlying bond. Once this price differential is in place hedge funds take advantage of this price differential and will buy Treasury bonds and at the same time sell corresponding Treasury futures. The upshot of this trade is that by selling the higher priced bonds in one market and buying the cheaper priced bonds in another market, the hedge funds can profit from the price differential. 

*Purchasing Treasury Bond Futures – Asset managers instead of buying actual Treasury bonds quite often prefer to buy futures because there is less upfront cash to pay. 

However, the profits from these trades are very small, and therefore heavy borrowing is required in order to make them more lucrative. Sometimes when there are unexpected episodes or events, this can quite often lead to market volatility leading to potential tragic consequences for the trade leaving the trader no option but to straight away unload all their holdings. This form of arbitrage*, as mentioned previously, requires heavy borrowing, and hedge funds usually borrow from the Repo Market**. It is normal for hedge funds to offer their Treasury bonds as collateral, as the normal practice is to roll-over these loans on a daily basis. Experts advise that these trades can be quite risky due to the amount of leverage involved (on average USD50 for every USD1 invested so 50 times leverage), plus a big reliance on short-term borrowings. 

*Arbitrage – the simultaneous buying and selling of currencies, commodities or securities in different markets or in derivative forms in order to take advantage of the differing prices of the same asset.

**Repo (Repurchase Agreement) Market – In this market money market funds, banks and others lend short-term capital against government securities, in this case US Treasury Bonds. Basically, in this transaction a borrower temporarily lends a security to a lender for cash with an agreement to buy it back in the future at a predetermined price. Ownership of the security does not change hands in a repo transaction.

When the Treasuries market experiences volatility, it can increase the cost of the trade thereby negating profitability, so hedge funds must very quickly unwind their trades in order to repay their loans thereby increasing volatility in an already volatile market.  Such fluctuations can see liquidity drying up and a decrease in the availability of buyers. In such instances* the Treasuries market can literally seize up, and with Treasury bonds being so fundamental to the credit market (and they are risk-free), the US Federal Reserve has had to intervene when the normal functioning of the market has become impaired. 

*Onset of the CoronaVirus – Back in 2020 when the Covid-19 appeared the huge volatility in the markets prompted margin calls in Treasury bond futures, amplifying funding problems in the repo market. Simultaneously, Treasury bond holdings were being dumped by foreign central banks in order to prop their own currencies with US Dollars. This prompted cash bonds to underperform their futures counterparts which is the opposite of the conditions needed for the basis trade to make a profit. It was never fully understood how much basis trading contributed to the turmoil in the market, but the rapid unwinding of positions by hedge funds certainly increased volatility. The upshot was the Federal Reserve promised to buy trillions of dollars of Treasury Bonds to keep markets running smoothly whilst providing the repo market with emergency funding. 

Basis trading subsided after the 2020 debacle but returned in early 2023 due the Federal Reserve monetary tightening policies by raising interest rates a record eleven times in eighteen months, which pushed up yields on 10 year Treasury bonds to circa 5%. On the demand side, this yield (highest since 2007) once again attracted large institutional buyers to buy futures, and on the supply side the Federal Reserve has increased sales of bonds to fund the US Government deficits, which has put downward price pressure on cash bonds. Therefore there is now a sufficient gap between the price of cash bonds and futures to have basis traders up and running again.

Financial watchdogs and authorities are unhappy over these trades, specifically because they are highly leveraged, and the fact that they are direct from one party to another. This means regulation is difficult, plus hedge funds themselves have much less regulation than banks. To this end, the Bank for International Settlements (BIS), the Bank of England and the Federal Reserve have called for closer monitoring of basis trades. Indeed the US Securities and Exchange Commission (SEC) finalised a rule in May of this year (starting June 2024)requiring all private funds to report sudden large losses, margin increases and any other significant changes.

Due to Government Crackdown, Chinese Quant Funds Suffer

 For many international investors who are eyeing the Chinese equity markets with suspicion, the recent and sudden trading restrictions is yet another reason to avoid the markets. Indeed, until February 2024, China has endured a record outflow from the equity market, and due to never before seen crackdowns on the property and tech sectors, foreign direct investment is at a thirty year low. Furthermore, as a result of the Chinese government’s efforts to halt a USD$ Trillion sell-off in stocks the Quant industry*, (once a booming and integral part of the equity market) it has suffered losses and is yet another casualty of government policy.

*Quant (Quantitative) Fund – This is a fund that identifies with automated algorithms and advanced quantitative models together with statistical and mathematical techniques to make investment decisions and execute trades. Unlike other funds (e.g., hedge funds) a Quant fund has no human judgement or intellect in investment decisions, and experts argue that the computer based models mitigate losses and risks related to human fund management. 

Market analysts advise that the new restrictions will require Quant funds to be scrutinised and regulators will demand that any new entrants will have to report trading strategies before actually trading. Apart from sweeping regulations that are harming Quant funds, they have been caught off-guard by government intervention. Due to the five year low on the *CSI 300 index, they took very hard and forceful measures to stabilise the markets, with Quant funds firmly in their sights.

*The Shanghai Shenzhen CSI 300 Index is designed to replicate the performance of the top 300 stocks traded in the Shanghai and Shenzhen stock exchanges and is weighted for market capitalization. As such, it is seen as a blue-chip index for mainland Chinese stocks.

First of all, in early February 2024, the head securities regulator was dismissed and replaced by a veteran known as the “Butcher Broker” due to his previous record of hard crackdowns Experts suggest that Quants were targeted as the authorities were concerned that declines in equities were compounded by Quant funds making short bets and unloading large blocks of shares. Therefore some Quant funds were limited in their ability to undertake short trades, which, combined with shifts in the market, inhibited and stifled Quant funds. 

Analysts advise that a favourite trade for Quant funds is purchasing small cap stocks as they are susceptible to mispricing and the quants computer programmes exploits this opportunity to gain profitability, whilst hedging market exposure by shorting index futures. However, declines in small cap stocks made sure that quant funds reduce holdings and the huge selling triggered losses in the derivatives market known as snowballs*. This caused further panic in the market (known as a quant quake) and index futures were dumped by brokerages as well. 

*Snowballs – A Snowball product is a structured hybrid derivative which pays a bond-like coupon and consists of additional options on basic financial assets, which include underlying assets such as stocks or stock indexes. The word snowball derives from the fact that coupons can be rolled over and coupon pay-outs rely on the underlying asset trading within a certain range. 

Finally the volatility that was in the equity markets impacted those funds (e.g. hedge funds) who had invested in what is known as market-neutral products* and in many cases had leveraged themselves up to 300%, thus forcing them to unwind their positions creating even more havoc in the market which was already going south. This prompted the authorities to prop up exchange traded funds via government-led funds known as the national team, which resulted in a boost for large caps stocks but ignoring the small caps. Data released showed some of the top Quant funds lagging behind the CSI 500 Index (a well-known indicator of the performance of Chinese mid and small cap companies), by circa 12 points for 2 week’s ending 8th February 2024.

*Market Neutral Products – These funds/investments are designed to target returns that are independent of market directions. This is achieved with equal long and short positions in any industry and by investing in equities where the long positions are expected to outperform their peers and the short equities are expected to underperform. Any losses in the short position are offset by profits in the long position.

Following the crackdown on quants the main equity index has risen in nine straight sessions including every day from 19th -23rd February 2024, the longest run of uninterrupted gains in six years. So for now, the strong arm tactics of the authorities are working to stop the downward spiral of equities, however experts wonder if Quant funds will continue operating where there are such arbitrary market interventions. The question is this: will investors be convinced this a one off intervention? Or will the image the authorities have tried to create over the last thirty years that China is committed to a professional and open market be soured?

The Growth of the Private Credit Market and the Potential Pitfalls

What is private credit and why has the  growth of this particular market been so spectacular? Looking back at the lending market as a whole, first there were the banks, then debt specialists and private equity entered the lending market, quickly followed by hedge funds and wealth managers. The private credit market really began to make its mark after the 2007 – 2009 Global Financial Crisis, when banks tightened their belts and pulled back from lending. Today, not only on Wall Street in the United States, but in all major financial centres, the buzz word on everyone’s lips from venture capitalists to sovereign wealth funds is private credit.

An explanation as to what private credit represents is where SMEs (small and medium-sized enterprises) who are non-investment grade and typically represent the recipients of loans from non-bank lenders. This market can serve as a diversifier as debt is less correlated to equity markets, and due to periodic income from repayments the J-curve is smaller*.

*J-curve – is a trendline that shows an initial loss followed by a dramatic gain, hence the j-curve.

In a nutshell private credit targets non-investment grade SMEs, and unlike private equity there is no direct management involvement. Any added value will come mostly from restructuring. The type of investments are usually direct loans which relate to senior instruments in the capital structure, often accompanied with bespoke terms and floating-rate coupons**.However, it must be pointed out that as the market has expanded so have the catchment levels, with the market catering to a more diverse base. 

**Floating-Rate Coupons – A floating rate note, commonly referred to as a FRN, is a debt instrument with a variable interest rate or coupon which is tied to a benchmark rate such as Libor (London Interbank Offered Rate) which of course has now been replaced in the US Dollar market by SOFR, (The Secured Overnight Financing Rate) and in the GBP market by Sonia, (Sterling Overnight Index Average). Many FRN’s have coupons that pay quarterly, and investors can benefit from increasing interest rates as the note adjusts periodically to current market rates.

The private credit boom has recently been driven by central banks monetary tightening policies which began in 2022 with unprecedented rate hikes over the next year to late 2023. The Federal Reserve raised interest rates ten times over in this period from a low of 0.25% to a high of 5.25%. Similarly in the United Kingdom, the Bank of England increased its key benchmark rate eleven times from a low of 0.25% to a high of 5.25%, and in Europe the ECB (European Central Bank) raised its rates seven times from a low of 0% to a high of 3.75%.

This has inevitably forced borrowers to look elsewhere to look for alternative lending sources, and the private credit market has benefited considerabley. Indeed, earlier this year in the United States, a number of mid-cap banks ran into liquidity problems, and this together with higher interest rates prompted some the more traditional lenders to exit certain business lines or unload assets. Hence, the retreat of bank lending, higher interest rates and bigger fees have brought a large number of new players to the private credit market, which has turned from what was essentially a niche market to a must-have market. 

Today the private credit market has expanded its philosophy to what has been described as a catch-all concept. Indeed, the market now incorporates traditional direct lending to the SMEs to finance buyouts, real estate and infrastructure debt. Experts advise that this will help fund managers to profit from strategies which can shield them from the volatility of mark-to market* losses in public markets. The expansion can be seen by the number of new players entering the market, such as large asset managers who are bolting on private market funds to their existing businesses or in the private equity world  increasingly using private market companies for their acquisitions. Indeed, the risk strategies employed by the new entrant private credit funds differ massively from one company to another. For example, some companies are offering high-risk mezzanine finance* to companies that are struggling, whilst mid-sized companies with fairly small or low leverage are being offered senior secured debt and private equity are being provided with funding for buy-out transactions. 

*Mark-to-Market – is an accounting practice whereby the value of an asset is adjusted to reflect its true value in changing market conditions. Furthermore, it is also where assets and liabilities are recorded at their current market value, and if a company had to pay off all their debts and liquidate their assets, mark-to-market accounting would provide an accurate value of what the company is worth at that time. 

**Mezzanine Finance – Mezzanine loans or capital can be structured either as subordinated debt or as equity, which is usually in the form of preferred stock. Mezzanine financing is recognised as a capital resource which can often be seen as subordinated debt and sits between higher risk equity and less risky senior debt. To facilitate the explanation of mezzanine debt, below are the definitions of senior debt and subordinated debt:

·      Senior Debt – often issued in the form of senior notes and also known as a senior loan, is a debt that will be paid first by the borrowing company. In other words, it takes priority over other unsecured debt and in the event the borrowing company goes into liquidation, owners of senior debt will be the first to be repaid.

·      Subordinated Debt – or as the name implies junior debt, is usually the last type of debt to be repaid. It has a lower status to senior debt and hence the name subordinated debt. Typically, subordinated debt or loans will carry a lower credit rating and will therefore offer a higher return than senior debt.

Mezzanine financing is a type of junior debt or capital and is viewed as the last stop on the debt borrowing chain or capital structure, before equity is sold in order to raise capital. Mezzanine financing allows companies to access capital beyond that of what can be accessed through senior debt. It is typically longer-term debt (7 – 8) years, and is interest only during the loan period, with amortisation at maturity. Many borrowers view mezzanine finance as “solution based” capital as opposed to permanent capital, serving a specific purpose(s), which can be replaced with lower interest-bearing capital such as senior debt at a later date.

The private credit market has increased by circa 300% in size over the last nine years, with experts valuing the market in the region of USD1.5 Trillion. Indeed, one of the largest alternative credit managers has advised that the industry could grow to the stage where it has replaced USD 40 Trillion of the debt markets. The private credit market began its life by catering to the private equity companies, and like the private equity companies they raise funds from investors. This however is where the similarity ends, as private credit lends debt to their clients whereas private equity as the name suggest invests equity in their clients.

Experts within the private credit market are referring to this boom as “debanking”, which according to one senior player is still in its infancy, while others refer to the current state of the private credit market as “The Golden Moment”. Both analysts and experts suggest that new banking regulations in the United States under proposed Federal Reserve rules will act as a catalyst for the private credit market, as the capital required to support the US wholesale banking industry could increase by as much as 35%. 

However, there are some dissenters from the regulatory arena in the United States who say that the private credit market could prove a risk to the US banking system as, unlike the banking industry, it is subject to indirect and somewhat minimal oversight. Indeed, the Federal Reserve has been requested by lawmakers as to what they, the FDIC (Federal Deposit Insurance Corp), and the Office of Comptroller of Currency were doing to address this issue. However, in a counter statement the American Investment Council trade group advised that private credit services were noy systemically risky and were quoted as saying, “ In this economy, private credit is helping small businesses to get capital to grow and succeed”.

Naysayers and detractors who say the market has grown to a point where there will be failures should not be ignored. Whatever the market, history has shown that there is always a crisis waiting around the corner. The Global Financial Crisis stands out as a case in point as does the mid-cap banking wobble in the United States earlier this year which spread to Europe and led to the downfall of the eminent Swiss bank, Credit Suisse AG. 

New entrants to the market are committing funds in the region of USD500 Million to USD1.5 Billion, despite the fact that some analysts are predicting that the market itself is coming under strain from rate hikes inflicted on economies through central bank quantitative tightening policies. Experts advise that most of the private credit investments that are outstanding as of today would have been contractually agreed eighteen months ago and would have been made against a completely different economic backdrop. 

Most private credit loans are arranged (as stated previously) on a floating rate basis, and the interest hikes over the last year could potentially have a significant effect on the performance of those companies and the funds invested therein. One expert suggests or rather confirms that the whole structure is now coming under strain. Many balance sheets of debtor companies have five to seven turns of leverage and if they had to be refinanced today then every dollar earned would go on interest payments. 

Many players in the private credit market have only experienced bullish tendencies; they have never experienced a bear market or a downturn. Recently released data shows that to date in 2023 the volume of defaults in the direct-lending market in the United States alone reached circa USD1.7 Billion. Indeed, some of the savvier participants are already hiring those with expertise in workout and restructuring including expertise in managing investments in a downturn. Market sentiment and data suggest interest rates are set to fall in 2024 – they can’t come soon enough for many in the private credit market.

 Final Call for Interest Rates Going into the New Year

On Thursday 14th December 2023 at the final MPC (Monetary Policy Committee) of the year, after a vote of six to three, the Bank of England maintained the status quo and left interest rates unchanged holding steady at a 15 year high of 5.25%. However, the rhetoric remains unchanged as the Governor Mr Andrew Bailey advised “There is still a long way to go in the fight to control inflation”. 

The governor further acknowledged that despite financial markets expectations, he pushed back against an expected rate cut in May 2024, as the MPC warned they may tighten monetary policy if price pressures persist. The MPC were quick to point out that the two key indicators of price pressure which are service and pay inflation remain elevated, and the United Kingdom remains the only major economy where food price increases remain in double digits, with the UK’s inflation figure of 4.7% being the highest of the G7 countries.

Across the Atlantic Ocean in the United States, on Wednesday 13th December 2023 the Federal reserve once again left interest rates unchanged. However, the Chairman Jerome Powell confirmed that the FOMC (Federal Open Market Committee) is still prepared to resume monetary tightening policies and increase interest rates should price pressures return. 

At the same time, in a more dovish stance,  the Federal Reserve leaned towards reversing their interest rate hike policies, by issuing forecasts that showed a number of rate cuts would be likely in 2024. However market experts pointed out that in November, increases in service-sector costs and in particular housing has kept inflation stubborn enough to counter any Federal Reserve interest rate cuts in the near future.

In Europe, the ECB (European Central Bank), along with their counterparts in the United Kingdom and the United States, kept interest rates on hold for the second meeting in succession. The deposit rate remains at a record high of 4%, even though inflation is heading south. The ECB confirmed that keeping interest rates high will make a substantial contribution to returning consumer price growth to the goal of 2% and they further advised that they will increase the speed of its exit from the pandemic era of stimulus which cost them Euros1.7 Trillion. 

The ECB will also increase the speed at which they are ending reinvestments under PEPP bond buying programme*, putting monetary policy tools into a tightening mode. Financial markets are expecting an interest rate cut in March 2024 despite Christine Lagardem, the ECB’s governors’, comments that policy rates will remain at sufficiently restrictive levels for as long as necessary. Markets noted with interest the wording “inflation is expected to remain high for too long” had disappeared from central bank rhetoric and was replaced with “inflation will gradually decline over the course of the next year”.

*PEPP Bond-Buying Programme – Otherwise known as the Pandemic Emergency Purchase Programme was an ECB instigated response to the Covid-19 crisis. Initiated on the 20th March 2020, it is a temporary asset purchase programme of public and private sector securities. These purchases cover sovereign debt, covered bonds (an investment debt comprising of loans that are backed by a separate group of assets), asset-backed securities and commercial paper. 

Elsewhere and outside of the major central banks, Norway increased interest rates for what is expected to be the final time with Russia also raising their cost of borrowing. Meanwhile, Mexico, Pakistan, the Philippines, Switzerland and Taiwan all maintained the status quo by keeping interest rates unchanged whilst Brazil, Peru and Ukraine all cut their borrowing rates. 

At the end of 2023, whilst the Federal Reserve, the Bank of England and the ECB all kept interest rates unchanged, it appears that the Bank of England will have a different policy to the other two central banks going forward in 2024. Whilst the ECB remains hawkish with an exit from the pandemic stimulus, there is still an anticipation of an interest rate cut in March of next year. The Federal Reserve has been more forthcoming issuing forecasts of interest rate cuts in 2024, with the most hawkish of them all being the Bank of England who are sticking by their statement that interest rates will remain high for as long as deemed necessary. However, recent data showing the UK GDP results being worse than expected may push the Bank of England into reassessing their monetary policy for 2024 forcing them into a small interest rate cut.