LONDON — Though some way from a peak in central bank rates, it’s just possible we’re seeing a peak ‘super hikes’ at least.
That may be thin gruel for optimists – but will be important in determining just how high rates go next year as economic growth screeches to a halt. Both the European Central Bank and Bank of Canada this week aped the U.S. Federal Reserve’s last two jumbo 75 basis point rate rises and the Bank of England looks like it may follow suit next week. And that’s all before the Fed executes a hat-trick of super-sized 75bp moves later this month.
Aside from Japan, which insists on standing pat even in the face of creeping inflation there and a plummeting yen, that puts most G7 central banks at full throttle in tightening credit to cut across decades-high inflation.
And despite still surprisingly benign baseline economic forecasts for next year from the Fed and ECB at least, many policymakers now acknowledge that the so-called ‘soft landing’ they are trying to steer their economies onto will likely involve some form of mild recession at least.
And as that may hit early next year after an energy-squeezed winter, the temptation for central banks is to go hard and fast now to get rates to levels where they pinch before a hawkish tilt at lingering inflation becomes harder with rising jobless.
Announcing the biggest rate rise in the ECB’s short history on Thursday, one of ECB chief Christine Lagarde’s buzzwords was ‘frontloading’ and markets assume that’s how it will play out.
Although Lagarde refused to rule out another 75bp move and said further hikes were due over the ‘next several meetings’, there’s a sense that this week was the biggest gun sounding.
“The ECB will aim to bring its policy rates into neutral territory reasonably quickly – (but) expect additional 50 basis point policy rate hikes in October and December,” said PIMCO portfolio manager Konstantin Veit, adding the ECB was likely to revert to quarter point moves next year.
Money markets have clearly taken notice of the ECB’s hawkish turn and expect it to raise its newly-positive 0.75% deposit rate to a peak of about 2.25% by May of next year.
Getting to that ‘terminal rate’ by then would clearly allow smaller hikes at the intervening five meetings – although some economists think even that may be fanciful given the winter’s energy risks.
“Given stagnating and potentially negative quarters of growth ahead, rates will not ultimately rise as high as the market currently expects,” said Lombard Odier economist Samy Chaar, adding peak ECB rates could be as low as 1.5%.
Silvia Dall’Angelo at Federated Hermes thinks the ECB is “exploiting a narrow opportunity window to raise rates aggressively” in the hope of stemming second round inflation effects – but she too thinks it would be forced to pause by the end of this year.
JUMBO HIKES OVER
But there’s a similar picture in Washington.
If the Fed opts for another 75bp move this month, then that would amount to a swingeing 225bp of policy rate hikes over just three meetings – the most severe tightening since the scorched earth policy of former Chair Paul Volcker in the 1980s.
And yet if an implied Fed terminal rate penciled in about 4% for the end of March holds true, then that would leave Powell and Co another 100bp over 3 meetings – slowing the current blistering pace of hikes.
With wild changes in forecasts for peak UK inflation next year, due to this week’s delayed government energy price cap and subsidy plans, the picture may be muddier.
But a similar scenario of hitting ‘peak super hike’ now would still play out according to current constellation of pricing – even before you get into a debate about whether the depth of the UK recession or additional government borrowing plans will even allow the BoE to get rates close to 4%.
As it stands, implied peak rates in the UK are about 4.25% for June next year – about 250 basis points above current rates and above where markets put long-term inflation expectations.
But again – if that terminal rate and date remain roughly the same after the BoE pulls the 75bp trigger next week, then it would leave six meetings over which to farm out the remaining 175bps of hikes. And swaps markets are currently leaning toward a 50bp move and then 25bp clips after that.
While all that won’t get away from an overall higher cost of borrowing – nor address how long rates stay there or even the effects of balance sheet unwinding on long-term bond markets in the background – it will dial down the shockwaves in more difficult times at least.
The opinions expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan, Twitter: @reutersMikeD; Added chart from Andy Bruce Editing by Susan Fenton)